- Acknowledge self control is difficult;
- The 'save more tomorrow' method;
- Automatic deposits;
- Wait thirty days for major purchases;
- Compound your expenses.
We know saving is hard.
It’s not your fault, our brain isn’t really built to be good at saving money. But there are certain things you can do to help yourself out. I hope by the end of this post you come out with an idea or two.
While it may be hard, saving is also important. Unless you’re the next Zuckerberg or you never want to buy a house, you need to figure out how to save.
And I know, it's possible you’re young. You’ll figure out how to save later but compound interest takes time. The sooner you start saving and investing, the sooner you can put your money to work.
Imagine you invested $5 today and everyday thereafter. In 10 years, assuming a 7% yearly return, how much do you have at the end? It’s about $25,000 or $25,225 if you want to be exact. After 20 years, this balloons to $74,836 and if we push it out to 30 years, it’s $172,429.
The more time you give your money to compound, the better off you’ll be.
1. Understand self control is hard
Our brains haven’t caught up with our environment and our desire for immediate gratification overwhelms the need for long-term plans. Most of us are terrible at self-control.
If you want to diet, do you keep chocolate in the house? No because if you do, every time you open the cupboard, you have to make an active decision not to eat it.
The same is true for saving. If you have to decide to save money, every time you want to save money, then there’s a chance you’ll decide not to. And the decision to spend money comes up all the time, so you’re always deciding not to buy things.
The solution is simple: make the decision once. If you want to contribute a little extra to your Super use salary sacrifice. Once it’s set up, you probably won’t notice the money is gone anyway. If you never see the money, you never have to worry about spending or saving it.
This is exactly what Netflix and Spotify are doing to you. They want recurring revenue, so they set you up with a subscription. Once you decide to buy it, then it’s all about making an active decision to cancel your subscription.
We all know how long those subscriptions can run before we finally hit cancel.
2. Save More Tomorrow
Save More Tomorrow was a principle developed by Richard Thaler, a behavioural economist, to help people save enough for retirement. The general principle can be applied beyond retirement, but before we get into what it is, let’s go through a bit of required vocabulary.
Saving for retirement isn’t getting any easier. Life expectancy is increasing and so is the amount of time we will spend in retirement. Naturally, that means we need more money in order to fund our retirement.
If you believe in the life-cycle hypothesis, you would believe that people will solve this issue themselves by calculating their appropriate savings rate and spreading their spending across their life.
I don’t know about you but I’ve never met anyone who thinks like this. I don’t think I’ve even met anyone who could tell me if how much they are saving is appropriate. And if I did, I’d be willing to be bet they wouldn’t be saving at that rate anyway.
The intention to save isn’t enough. The problem is saving is hard, especially when it feels like a loss. As humans, we are loss averse with some studies suggesting we’re affected by losses twice as much as gains. So most of us would rather not lose $5 than find $10. And when you have to cut spending in order to save more, that can feel a lot like a loss.
Behavioural economists call this the status quo bias, meaning we prefer the current state of affairs and any change in the baseline is perceived as a loss.
When we pair this with hyperbolic discounting, meaning people favour immediate payoffs rather than later payoff. It becomes clear why saving is so hard. We want immediate gratification even if it means we’ll have less later.
This led to Thaler creating Save More Tomorrow idea which can be broken down into four parts:
- Because of hyperbolic discounting, people tend to prefer saving later than now. So, we should get them thinking about saving as early as possible.
- Increase contributions after people get a raise. They won’t experience a loss in pay and by avoiding the feeling of loss, it’s easier for them to accept an increase in contribution. It also reduces the reliance on self control, it’s automatic.
- Gradually increase contributions by percentage points until a pre-set maximum is reached. This means people have to opt-out of the program. Or as a behavioural economist would say, the default behaviour is to stay with the program (like a Spotify subscription).
- You can opt out at any time.
It sounds simple but Save More Tomorrow works. In the initial study, 78% of people offered Save More Tomorrow elected to use it; 98% remained in it through two raises and 80% remained in it through the third raise.
What is more impressive is the average saving rates increased from 3.5% to 11.6% over the course of 28 months; a 231% increase. Fantastic.
If you’re trying to save, try saving more tomorrow.
3. Automatic deposits
Whether you have access to a Save More Tomorrow arrangement or not, you can still take advantage of the underlying principles. The easiest way is setting up an automatic deposit into a savings or investment service of your choice.
The trick is to pick a number that you will stick with. Once you get comfortable saving, you can increase the amount (or increase it with each raise). It’s not as automatic as Save More Tomorrow but it can help.
4. Wait 30 days before you buy anything
Impulse spending eats away at your bank balance, a little here, a little there and you’ve spend half your paycheck. That’s why many people suggest setting a minimum waiting period for purchases above a threshold, say a 30 day wait for anything over $100.
Not only is 30 days enough time to think about whether you need something or not (and most of the time you don’t), it also gives you the time to research and find the best product at the best price.
5. Compound your expenses
There are many ways to think about expenses, here’s a few examples:
- I want it and I don’t care how much it costs — I’ll put it on my credit card and think about it later.
- It’s only $100 a month. I can afford that, I have $50 left over each week anyway.
- If I invested that $100 a month for ten years and earned a 7% return, how much would it be?
The answer to number three is nearly $17k ($16,776, that’s a profit of $4,776). The question then becomes, is that $100 subscription really worth more than $17k later?
At Spaceship, we are always trying to help you think about things as long term events, we hate short-termism. An easy way to think about it is to carry each decision forward ten years, rather than your next paycheck.
Here’s another example. You buy two coffees a day at $3.50 each. $7/day = $49/week = $36,850 in ten years at 7% annual rate of return. When you think about it like this, everything costs more than it seems. Rather than worry if you’re next paycheque will cover it, try thinking about alternatives, like investing it.
Saving money doesn’t have to be hard. You just have to set up systems that help you. The key is to rely on systems, not willpower to get you to where you want to be.