Saving money is hard.
If it was easy, everyone could do it. We wouldn’t have the consumer debt crisis we have. We wouldn’t be struggling with financial literacy. We probably wouldn’t have Thriving Millionaires. But the fact is, it isn’t easy.
Because it isn’t easy, it’s important to figure out a system to help you save and set yourself up for financial success in the long run. One of the best ways to build a system is to automate as much as possible to keep your savings on autopilot. This removes some of the challenges associated with savings – remembering to transfer money, remembering to invest in a diversified portfolio, remembering to contribute to your 401k or IRA, etc.
I won’t discuss how to build your financial plan to free up money to save – but I will discuss ways to automate the savings of money you’ve already freed up.
One way you can help automate some of the work required with savings is to set up automatic transfers at your financial institutions of choice. Here are two ways I currently use automatic transfers:
1. Automatic Transfers to a High-Yield Savings Account
We use a major bank for the majority of our day-to-day banking needs. Direct deposit of pay checks, online bill payment, brokerage investing, and even convenient physical locations and ATMs. The benefits of having accounts with a traditional bank are many, so we continue to use this bank for our regular financial activity. However, we also have accounts with some online-only banks that pay higher interest rates given their lower overhead expenses. To ensure we’re earning a high interest rate on any cash, but while maintaining the convenience of a traditional bank, we have automatic transfers each month from our traditional bank to our online savings account.
Based on our budget, I know how much money we plan to bring in and how much we plan to spend. The difference is the amount that I have set up as an automatic transfer to our high-yield online savings account. This is important because it not only ensures that they money begins to work harder for us with the higher interest rate, but it also quickly puts the money into a savings account which helps prevent over-spending.
2. Automatic Transfers to our Brokerage Account
Each month we aim to invest a set amount in various ETFs. However, because this is a monthly action, it’s easy to forget to do it for a month or two. By setting up automatic transfers from our checking account to our brokerage account, I know that the money is being placed into our trading account to be used to purchase these various ETFs. The automation also serves as a great reminder – when I see the transfer transactions in Mint, I know it’s time to get into the brokerage account and place the order to buy these ETFs. This helps keep us on track with our planned investment strategy.
And, as a side benefit, similar to the above, it helps move the money out of our checking account and keeps it out of reach – which helps prevent over-spending of money that we have earmarked for investment.
Automatic Contribution Increases
If your employer offers a retirement plan like a 401k or a 403b, there is a good chance that the plan also offers a feature to automatically increase your contribution rate. The concept is that you can specify a contribution percentage increase and the timing of the increase so you can, over time, increase your retirement savings.
It works like this:
Let’s say you are currently contributing 5% of your salary to your 401k plan at work, but you desire to be saving 10% of your salary eventually. Making the jump from 5% to 10% can be a significant change to your take-home pay, which is why most people struggle to save such a high percentage of their salary. However, let’s assume that every year in April, you get a raise – generally between 4-6%.
By setting an automatic contribution increase of 2% per year and specifying that the change occurs in April, you will continue to contribute 5% for the rest of this year. But then next April, when your salary increases 4-6%, your contribution percent will increase from 5% to 7%. By aligning this contribution increase with your salary increase, your salary will still increase a net 2-4%, but you will also be 2% closer to your 10% goal. Then, the following year in April, your contribution will increase from 7% to 9% while still allowing you to increase your net salary by 2-4% again.
By aligning your automatic increase in contribution percent with your salary increase, you will still see an increase in your salary (while slightly smaller), but also be making automatic progress towards your retirement savings goals.
There is no trick to saving money. It requires a lot of hard work and, in many cases, sacrifice. But by using tools available to you through technology such as automatic transfers or automatic contribution increases, you can put some of the work on autopilot.
The concept of automation is one that we love as human beings. You install automatic lights outside of your house. We got sick of changing gears so we put transmissions in our cars that automatically do it for us. The host of connected digital devices provided to us by Google Home and Amazon Alexa make everyday, simple tasks easier. The fact is, we love automation. So why don’t more of us do it when it comes to things like savings?
I think one of the biggest reasons for this is that many of us aren’t always aware of the impact automatically saving a small amount from each paycheck can have. A while back we talked about why it was important to build an emergency fund. The task can seem daunting at first, but if you break it down into bite-sized contributions, you can steadily build this fund over time.
Let’s say I wanted to build an emergency fund of $10,000. I currently have $4,000 saved, but finding that extra $6,000 seems like it will be difficult. If, instead of finding a way to instantly do it, I start saving $125 a week, in approximately a year I would reach my goal. It’s much easier to accomplish with an automatic weekly withdrawal than by trying to make it all happen at once. This is why automatic saving is important: it’s more manageable and you won’t miss the money as much.
One of the other ways I love to look at automatic saving is in terms of reducing future obligations. Many of us need to take out some sort of loan to make major purchase like a house or a car. Often times, especially with a house, these come with long payment terms and big payments. This means that over time we spend a significant amount of money on interest over the life of the loan. One of the best ways you can decrease this amount, and reduce your term, is by making automatic principal contributions each time you make a payment. Most mortgages and car loans don’t have penalty’s for this, and it can go a long way towards reducing your overall payment.
Let’s say you have 25 years left on a 30 year mortgage. You’re interest rate is 4.5% and your monthly payment is approximately $1,013. By contributing an extra $200 a month to your mortgage payment you do two phenomenal things. First of all, you pay off your mortgage 6 years and 6 months early. That’s a long time to not have a mortgage payment! The second, and more important thing, is that you reduce your overall payments by around $35,000. That’s money that you could apply to a college fund, a home renovation, or another investment!
I completely agree with Eric’s points above, and I’d challenge you to find other ways to automate your financial planning. At the end of the day, financial success is achieved by a lifestyle that prioritizes small, frequent, and smart decisions that compound over time for maximum impact. Take advantage of this and start today.