When it comes to increasing the size of your nest egg, there’s no substitute for the power of brute force savings. No investing trick can really increase your wealth in a vacuum without continued meaningful and regular contributions from your income. If you’re shooting for FIRE, a high savings rate is absolutely mandatory both in building your nest egg and in keeping your annual expenses down in preparation for life without a (regular) salary. Unfortunately, increasing your savings rate is really difficult, because it usually requires changes in your spending habits. There’s a lot of inertia between you and the major lifestyle changes that are necessary to overhaul your finances, and your brain is hardwired to maintain your current lifestyle routine as a default. Fortunately, there are a few tricks you can use to defeat the psychological barriers between yourself and increased savings.
- Automate your contributions. No matter what your savings goal is – building up an emergency fund, saving for a down payment, saving for retirement – this step is a no-brainer and by far the most important. By taking choice out of the equation, you don’t have the opportunity to choose not to save in a certain month or pay period. In a way, you’re taking money away from the pile you could otherwise choose to spend on discretionary expenses like entertainment, dining, and toys, and moving this money to your savings pile. You’re paying yourself. If you haven’t done this yet, your banking website will have an option for automatic/scheduled transfers. If you don’t think you have enough room in your budget to pay yourself first, do it anyway. Start with a small amount that you can increase over time. The same inertia that prevents you from saving in the first place will then be working in your favor.
- Use separate bank accounts for different goals. When we took a hard look at our finances and changed some things a few years ago, we decided to separate our checking accounts into a fixed expenses account and a discretionary spending account. This let us be very deliberate about how much money we were allowing ourselves for frivolous pursuits with every paycheck, and made it easy to drastically limit this. Since most bank accounts are easy to keep fee free, there’s no real limit to how finely you can subdivide your accounts for specific goals. Some people choose to have separate banking and brokerage accounts for emergency fund, down payment fund, travel fund, etc. Of course you could just share a couple of main accounts and keep consistent with a budget on a spreadsheet, but physically separating your accounts may be a quick trick to enforce your own savings rules, minimizing the risks of extra spending in a moment of weakness.
- Identify your single biggest discretionary expense and attack it. This requires making a budget, taking a hard look at it, and actually tracking your spending. Most bank websites have programs to help with this, but the problem is that these spending trackers may not capture the whole picture of your spending if, like many people, you have accounts at multiple institutions. You have to sit down and have an honest accounting of the total picture of your spending – including every credit card, bank account, and brokerage account. Categorize your spending into necessary/fixed expenses and optional/discretionary expenses. If you’re using a spreadsheet, some numbers in the discretionary category should easily pop out at you. Until we did this, we didn’t realize how much we were collectively spending per month on coffee. Armed with the knowledge that this was a bigger drain on our finances than we thought (and robbing from our savings), we were able to attack that expense head on. Now, for most physicians, coffee is really more of a mandatory expense than a discretionary one. But it doesn’t have to be a latte at the coffee shop. We found out that grinding beans from the grocery store and bringing coffee to work in a thermos (with the rare, exceptional coffee shop visit) was a drastically cheaper way to support our drug habit than (sometimes multiple) daily coffee shop trips.
- Put extra money from spending cuts, refunds and windfalls directly into savings. Got a one-time $25 rebate check in the mail? Put it straight into your savings. Saved $100/month by cutting out cable TV? Don’t spend it elsewhere, just increase your automatic contributions to savings. Tax refund? Work bonus? Savings. You get the idea. We often view these one-time injections of cash, small or large as an excuse to spend more or treat ourselves. If you really want to increase your savings rate, all of these should be earmarked for savings, and your spending should come out of your regular budget. Don’t even think about what to do with extra money you find yourself with. If you haven’t already accounted for it in your spending budget, there’s no reason it should be paid to someone other than yourself (in your savings or investment accounts).
- Ignore your raise. Just like with one-time windfalls, we have a tendency to view an increase in salary as a justification for taking a few more steps on the hedonic treadmill. If you’ve established a budget and it’s getting the job done, don’t you think an increase in your income should be paid out to yourself rather than some retailer or car dealership? A corollary to this rule is to do what you can to increase your income, so that you can have more available for savings. Do what you can to harness the power of brute force savings and plow any extra money you may find yourself with into your savings. Jason Zweig in Your Money and Your Brain points out that the jolt of pleasure you get from an improvement in your financial status is every bit as powerful as the jolt you get from other external stimuli like sex or drugs. If you put your raise right back into your savings by means of increased automated contributions, you can get the pleasure of seeing your net worth increasing faster.
- Reevaluate your budget and savings contributions at regular intervals, and always increase your amount, even by a little bit. So you’ve already got automatic transfers set up from your checking to your savings, your IRA, or your taxable investing account. Great start. But the only way to increase your savings rate is to increase your savings rate. Even tiny incremental increases over time add up to a lot. You’ve heard of the debt snowball method for clawing your way back up out of debt. Don’t let the snowball stop when the debt is gone. Keep the momentum by constantly rolling new money into your savings automatically. You already contribute $800/month and there’s not room in your budget for more savings? Make it $820. That extra $20, if invested at a 5% rate of return, would turn $9,819 savings over a year into $10,065. Small changes over time can make a difference.
We know that your brain, in addition to being the source of your analytical power and complicated executive planning and decision making, is hardwired to respond to fast rewards and instant gratification. The way to defeat this in your financial life is to eliminate opportunities for your brain to succumb to temptation from fast rewards. Automate your savings and work to constantly rob your reptilian brain of the opportunity to squander your savings. Your advanced, executive brain can help you do this with some dispassionate forethought. Both brains will thank you when your financial wealth skyrockets.
Have you used any similar tricks to increase your savings rate? Do you have any experiences – positive or negative – that you’d like to share about your struggle to save your way to financial independence? Leave a comment below.