It’s All About Priorities
One of the very smart people we have in our industry is a friend by the name of Michael Kitces, an advisor, financial planner, blogger and speaker extraordinaire based out of the DC area.
Today, he tweeted one of his old blog posts about savings, which led to a great Twitter conversation that expanded to involve another very smart person, my pal Brian McLaughlin, who is CEO at Redtail Technology.
Michael boiled down his post to a tweet: “Controlling your long-term SPENDING is what matters. Savings is an outcome.”
And I have to say, even though I agree with Michael far more than I disagree with him, this was one of the times that I fundamentally disagreed.
To make my point, I’ll digress for a quick moment and zoom up to the 30,000 foot view of investing. Some of the smartest and best-intentioned folks in our industry tell average investors “stop thinking you’re smarter than the market! Quit watching CNBC! Quit making decisions to buy or sell based on what your statement says!”
Fundamentally, that advice is headed in the right direction. After all, if you invested at the worst possible time — the market high pre-2008 — and then capitulated and sold in early 2009 near the bottom, you lost half your money. Many, many people succumbed to fear and did just that.
On the other hand, if you invested at the worst possible time and simply did nothing as the greatest market crash since the 1930s happened, you’d be up 50% today — an annual return of 8.3%.
But here’s the problem. Human behavior does not lend itself to putting one’s head in the sand. We are wired to be alert to danger and take action to protect ourselves. In fact, the data shows that we are 2.5x more averse to losing what we already have than not gaining what we could have gained.
One of our core philosophies at Riskalyze is not to reject the reality of human behavior, but to empower advisors to help their clients thrive by harnessing human behavior. When you help a client capture their Risk Number, and build a portfolio they can stick with during normal downturns, they are far better prepared to trust their advisor when the big downturn comes.
Now, how does this apply to savings?
One of the best things we can do as humans is harness our natural tendencies to spend 100% of what we have. And we do that by playing a very simple trick on ourselves: hiding the money we need to save.
Do yourself a favor, jump into your online banking and set up a recurring transfer to savings that happens on the same day your paycheck deposits. You can make it for as little as $25. Wait for a couple of months and see if you actually notice that you have less money. Trust me: you won’t.
I do this transfer to my IRA, but you can use another savings account too. If you’re smart, you might even do it at another bank so you can’t even “see” the money in your online banking and it’s not quite as easy to transfer it right back.
When your next raise arrives, figure out the post-tax increase and steal a good chunk of it to boost your savings transfer. Or just set a reminder to escalate your transfer by $25 every month, and ease into it.
Either way, you’re tricking yourself into saving. Human behavior will drive you to splurge — a Starbucks here, an Uber there, an extra movie here or there. You will definitely continue to be likely to spend 100% of what you make. And yet, you’ll be accomplishing your savings goals at the same time!
Now, let me say: if you’re someone who struggles with spending 110% or 120% or 130% of what you make right now, you have a different problem. Making saving your first priority will not solve an overspending problem.
But these are two separate issues. You cannot solve an overspending problem by moving saving to the end of your priority list. You solve an overspending problem by choosing to live within your means. (More income can help, but chronic overspenders know it’s not a silver bullet).
Ultimately, that’s why I differ with my friend Michael and his idea that savings is an “outcome” of spending. Making savings the bottom part of the equation is the choice millions of Americans are making today and that’s why we have a low-to-negative savings rate at any given point.
Life is all about choices and priorities. Harness human behavior by saving first and spending 100% of what is left, and you’ll end up in far better shape than putting savings last in your financial equation.