Sometimes it is the serendipity contact who can give you inspiration. “No matter what you do, pay yourself first. Even if it is only $5 a week, put that aside for yourself,” said an Uber driver in Washington, D.C. who explained how she managed to escape the relentless pressure of non-stop bills and save enough money to support her grandchildren. Whatever your source of insight, be sure to first put aside money for yourself. Then see what is left for the rest of life’s needs.
My story as a young banker
Saving was always easy for me. When I was a child and my allowance was paid in quarters, my mother would frequently use me as her piggy bank when she was short of change. She repeatedly “borrowed” from me and then forgot to repay me. So after a few times, I started keeping a hand-written table of the amounts and dates of her borrowings. When I needed money for birthday or Christmas presents, I showed her my ledger and with an embarrassing laugh, she immediately repaid me. (I suppose I was born to be a banker).
When I took my first post-training job in San Francisco in 1980 as an International Officer for Security Pacific Bank, my kindly landlady advised me that what was important was not how much I earned but how much I saved. That day, I started savings 10 percent of my monthly paycheck. By the time, I was in in 50s, I was saving 45 percent and later 60 percent of my after-tax income.
Today’s pressures can make it difficult to save for tomorrow
But for most people, immediate pressures make savings difficult. In researching ways to save, I found the best source to be a set of weekly financial diaries that tracked the spending of 235 families in four parts of the country — California, Mississippi, New York, and the Ohio-Kentucky border. They were considered as low and middle-income households, referred by local organizations and selected from an extensive multi-year database. The Panel Study of Income Dynamics of the University of Michigan has been running since 1968 and is considered by academic researchers to be the longest running longitudinal survey of household finances in the world. The researchers had access to the financial records of all 235 families and tracked all financial transactions for a year, with an average of over one million records per family. In addition, they sat down in the kitchens and living rooms of each family once a week.
Month-to-month ups and downs can be a killer
What emerged from the 2017 U.S. Financial Diaries study was the extreme volatility of household income. On average, income increased or declined by one-quarter or more for at least one full season – 4.6 months out of the calendar year. One could only ask, how did any of the families save when they could not know how much money would be coming in for numerous months out of the year?
For the households that did succeed in saving, one of the best techniques was to set up automatic savings transfers – and to place them in an account that was difficult to access. The most common approach was to split payroll deposits with some of the money going to a bank account used for savings and the balance going into the main checking account. Another person went even further. She opened a bank account in a town several miles away from her home and then cut up the ATM card that arrived in the mail. She then instructed her employee to set up split deposits with some money going that to that account. To get cash from her faraway bank account, she was obliged to drive an hour out of her way and stand in a teller line during the limited hours when the bank branch was open. Just the thought of going to that much trouble to withdraw her money discouraged her from making the trip too often.
Robert did it another way. He needed to save $1,600 for the security deposit and first month’s rent on a new apartment. So he asked his mother to hold on to the money that he gave her for safekeeping. It worked very well for Robert. He kept transferring money to his mother and before he could keep track of it, he found that he had saved more than $4,000.
My father did the same thing – albeit inadvertently — when he was working on radar in the Canadian Airforce during World War II. He sent his full salary home to his invalid mother to pay for her living expenses. She instead saved all the money for him and gave it to him when he was discharged. He wanted to buy a car but she insisted he use the funds to go to college. My Dad would never have become a successful financial executive if he had not had his mother saving for him over those five years.
Automatic savings work
Automatic savings work for three reasons. First, automatic procedures remove the ambiguity aversion that can paralyze decision-making (and thereby increase procrastination). As seen in Hack #1, making compounding work for you – and not against you – only works if you give it time. The earlier you start, the more effective it is. Not having to think about means that the transfer gets made, regardless of whether or not you remember to do so.
Second, automatic procedures eliminate reliance on self-control You no longer have to invest time and energy in each small decision. Third, automatic savings can make you feel smart and successful. Some people feel less than competent when asked to provide estimates on such complex issues as assumptions on likely future wages or rates of inflation, as are often requested by the online calculators that endear themselves to the numbers folks. Automated decisions eliminate the need for such estimates that even professional analysts have trouble with.
Automatic enrollment in 401(k) plans use the same theory. The popular Nudge Theory, as propagated by Cass Bernstein and Richard Thaler, argues that when new employees are offered 401(k) accounts by the employers – with an offer of free money as a match – only about 35 percent of workers sign up. They attend the presentation, take the forms home and then never sign up for the company’s pension plan. However when a different tack it taken, more people sign up.
Nudge theory explains why
Extensive research shows that when new employees are automatically enrolled in a 401(k) plan and advised that they must fill in a form to withdraw from their plan, over 80 percent are still enrolled some five years later. Now a number of states, including California, require automatic enrollment of workers in the 401(k) plans for companies with at least five employees. Some forward-thinking companies take this a step further and set up automatic escalation of the 401(k) contributions so that as a worker earns more and more income, additional funds are added to her or his pension plan.
In behavioral economics, the use of choice architecture as a way of encouraging people to move toward sensible finances has gained political enormous support in recent years. It allows people to opt out of the programs but uses procrastination to work in favor of the individual rather than against the person.
Joining a pension plan builds confidence in the future
Also surveys by the Employee Benefit Research Institute reveal that workers feel more confident about their future retirement by simply being part of a pension plan, be it a 401(k) or an individual retirement account (IRA) or some other formal plan. It feels good to think that you have prepared for the future.
This applies even for those interruptions in your career when you have little or no income, such as time taken off for child care or the time between one job and another. Even if you have no money coming in, it is best to set aside funds for your retirement in an Investment Retirement Account or any other long-term savings account where you can take advantage of the compounding of interest on your account.
Find a way to pay yourself an extra month’s pay
Even programs that require that you save at the same as you borrow are popular. Overwhelming those enrolled in a “Borrow and Save Program” of the National Federation of Community Development Credit Unions say that they appreciate the opportunity to save along the way. In the U.S. Financial Diaries study, some people use refunds on their personal income taxes as a way of getting a 13th month of salary. They deliberately inform their employers that they wish to take a higher level of deductions that will be necessary – just so that in the new year, they will have an extra’s month of income to pay off their bills from the Christmas holiday season.
As one other idea, the Financial Diaries also showed that participating in a savings club can help build peer support – getting your friends and neighbors to provide moral support – to ensure that you meet your savings goals.