If you’ve ever talked to any financial advisor or money expert, you’ve probably been told that automating your savings is an important task you should take care of ASAP. Not only is this a fantastic way to ensure that a pre-determined portion of your paycheck gets put away every month towards saving, but it also helps build wealth without requiring any active participation from you.
If you’re thinking that you can achieve those two things by consciously moving a portion of your money to your savings account every month, you could absolutely do that. But according to psychologists, it’s much easier for you to do this by automating the process.
This is because humans are prone to inherent errors and biases. You could put off transferring the money, ultimately never doing so at all, or simply forget to do it. Plus, by automatically removing a chunk of your income at the get-go, you are much less likely to see it as a part of your disposable income, i.e. you won’t feel like that money is yours to spend at the moment. Therefore, automating savings helps curb your need for immediate satisfaction.
Automating savings isn’t a new trick either, and it may be more common than you think. If your workplace has an employer-sponsored 401(k) or other retirement accounts, it is likely that you are already participating in it as a percentage of your paycheck is automatically invested in your retirement. If people were left to decide how much and when to deposit money into their retirement accounts, chances are that the payments won’t be as consistent or as timely!
So, why is automation such an important tool when it comes to savings?
Automating Savings Helps Avoid Present Bias
Human psychology says that people are always seeking immediate satisfaction. When faced with the choice of your current and future selves, you are much more likely to choose your present self. If given the choice to put money in your retirement account or splurge on yourself, you’re more likely to go with the latter.
This thought process, something that psychologists call “present bias”, is why it is so hard for us to compromise on our current desires to put money away for the future. The farther into the future the alternative option is, the less important it seems – which is why saving for retirement seems so hard. Plus, saving for things like buying a house seems too overwhelming and large, tempting you to spend what seems like insignificant amounts of money when instead.
Automation is the best way to overcome present bias as it takes away your choice between spending and saving altogether. You are no longer in the driver’s seat when it comes to deciding whether you want to save that extra money or not – it is done before you can even think of spending it!
If you are automatically enrolled in a 401(k) plan at work, you would have signed on to put a certain percentage of your paycheck, ay 4%, towards it every month. Therefore, the choice of whether you should put that 4% towards retirement or spend it on something else isn’t really there as that money never lands in your account in the first place.
However, even if you don’t have an employer-sponsored 401(k) account, you can still set up automatic transfers from your bank account. These could go towards your retirement account, investment account, or even towards making payments for things like rent and utilities. This way, all your essential expenses, including saving for retirement or any other major financial goal, are taken care of without you even having to think about it.
This is why the automation of savings is one of the major pieces of advice financial experts give their clients. It’s been around forever, and the reason for that is that it actually works! And here’s how you can do that:
How to Automate Your Savings
Automating your savings is pretty easy to do, and once you set it up, you don’t have to think about it anymore. If you receive your salary into your bank account, set up an automatic payment to your savings account on the same date every month, ideally, the day after your salary comes in. If you use direct deposit, you can update it to split your paycheck between your paycheck and savings account before it even hits your account.
This way, you wouldn’t even have the choice of spending the money that you intend to save. Plus, you don’t have to feel guilty about spending the money left in your checking account.
As for where you should automate your savings, a high-yield savings account is one of the best places to keep your money, especially if you are saving for a short-term goal such as buying a house or car. These accounts offer higher interest rates compared to traditional savings accounts. This way, your money can grow instead of lying idle and losing value over time.