If I’ve learned one new thing in six years of blogging about money, it’s this: The most important factor in financial success is not having a budget, meticulously avoiding debt, or choosing the right investments. It is having a system that makes the right financial moves for you. Automatically.
The key is to put your money on autopilot.
Why does something so simple matter so much?
The Behavior Gap
Because we’re human, and we do stupid things. In his blog and new book by the same name, doodling financial planner Carl Richards coins this “The Behavior Gap“.
Looking at the long-term returns of investments like the S&P 500 compared to the returns of individual investors, Richards found that the investors consistently did worse than the investments. He explains the difference, The Behavior Gap, as humans’ tendency to let emotions influence decisions (for example, to sell off stocks during scary economic times or buy a particular stock based on a tip in the financial media).
Emotions can lead us to make a lot of terrible financial decisions like:
- Making a big purchase you can’t yet afford—perhaps an engagement ring or a wedding dress—on a 19% APR credit card.
- Taking on too big a mortgage because it’s “your dream house”.
- Cashing out your 401(k) because you’ll “feel more secure” with cash in hand.
Putting your money on autopilot can’t stop us from all of the stupid things we do, but it goes a long way in protecting ourselves from two of the most common:
- Ceding to temptation.
- Being lazy.
Emotional decision-making is part of the problem; pure temptation is another. If you have ever tried to resist a temptation—to turn down an extra drink, to surf YouTube instead of working, to buy something you shouldn’t—and failed, you know what I mean.
Psychologists have shows that although it is possible to stretch and strengthen our willpower like a muscle, our ability to self-regulate is a consumable resource that depletes. What this means is:
- The more we exercise self-control, the better we become at it in the long-run.
- BUT, the more we use self-control in the short-run, the harder it becomes in the short-run (Muraven and Baumeister, 2000).
So if you focus on not procrastinating every day for a month, you may find it easier to diet next month. But if you’ve had a particularly exhausting, stressful day at the office and you’ve been fighting off distractions to get stuff done, resisting the candy bars in the checkout aisle (or going out to dinner even though you don’t have the money) may be all but impossible.
Although we can work to improve our self-control in the long run, as humans we’ll always be susceptible to moments of weakness when our self-control is depleted. To prepare for this inevitability, we can alter our environments to remove or reduce temptations.
An obvious example is that cliché advice that debtors should cut up their credit cards or put them in a block of ice. The next time your willpower is depleted and you want to charge the Forever Lazy you saw on a late-night infomercial, you may have second thoughts by the time your Visa defrosts.
Sometime we do stupid stuff because we are emotional or tempted. And sometimes we’re just lazy.
If you currently pay for a monthly subscription that you don’t use—a gym, a magazine, $12 a month for DVR service on cable—and don’t do anything about it, whose fault is it? The recurring-subscription business model that gyms, cable companies, and Netflix use is one of the most stable and profitable in existence. And guess what? It is built on the simple fact that people are lazy. When we stop using something, most people will pay $20 or more each month for many months before making a 10 minute phone call to cancel.
Laziness hurts our wallets in all sorts of ways.
Overspending on credit cards or paying for unused subscriptions are just a couple of ways our behavior sabotages our finances. Other examples include:
- Forgetting to pay bills, incurring late fees and credit penalties
- Depleting savings by comingling them with everyday spending money
- Failing to invest enough for retirement
- Failing to invest in regular intervals
There may be different reasons for making these mistakes, but don’t discount laziness. If you’ve ever thought of cancelling something you don’t use or opening a Roth IRA or increasing your 401(k) contributions and said “I should look into that” but haven’t done it yet, your laziness has already cost you money.
Why Automation is the Answer
Think about your daily habits.
Most likely, you brush your teeth every day and don’t even think about. It doesn’t take willpower to brush your teeth. It’s automatic.
Now think about something you’d like to do but are struggling with; perhaps it is to quit smoking, lose weight, or spend less.
These things are difficult to do. They take conscious effort—active self-regulation—to achieve. Meanwhile, the corresponding bad habits (smoking, overeating, spending money) have become automatic.
But talk to somebody who has successfully changed a habit—for example, a daily exerciser—and you’ll hear that it’s the good habit that is now automatic. Getting out of bed to jog becomes as routine as brushing your teeth.
Your brain has an autopilot!
When your can teach your brain to include a habit on autopilot, maintaining it takes much less effort, if any at all. Better yet, seemingly tiny habits can have big ripple effects.
In the book Willpower: Rediscovering the Greatest Human Strength, the authors explain how even small automatic behaviors can trigger better decisions. For example, have you have ever felt like when you’re well dressed, you work harder? There’s something to that.
Studies show that little habits like shaving, dressing neatly, and keeping an organized home correlate to more self-control in other areas of life. People who exhibit these behaviors are more likely to exercise, eat less, moderate alcohol, even use condoms more often.
So the more good habits you can put on autopilot, the more success you may have regulating other areas of your life.
And when it comes to putting your money on autopilot, your brain has an ally in technology. Twenty years ago, automated personal finances were impossible. Having your paycheck directly deposited was still cutting edge, and paying bills meant cutting a check every single month. Today, it’s not only possible to have an entirely electronic checking account, it’s becoming the norm to do away with paper checks altogether. And these new financial technologies make it possible to put your money entirely on autopilot.
A Simple Approach to Putting Your Money on Autopilot
As you get older, your finances will get more complicated whether you want them to or not. So the simpler you can keep your financial system, the better. Two primary accounts—one checking and one savings—should suffice unless you own a business or are married with separate finances.
The Three Steps to Automatic Finances
- Put your savings on autopilot
- Put your bills on autopilot
- Put your investments on autopilot
Here’s what somebody’s basic financial autopilot looks like.
Today we’ll cover setting up your savings and bills, next time we’ll talk about investments.
Put your savings on autopilot.
The first step in putting your money on autopilot is to pay yourself first. This means directing a portion of the money you earn into a savings account as soon as you earn it.
- If you’re still working on your emergency fund, put this money towards that.
- If you’re in high-interest consumer debt, put this money in an account that automatically makes extra payments on your debt each month.
- If you’ve funded your emergency fund, then put this money towards your next life savings goal (e.g., a house, a car, a wedding, or a vacation).
- If you’re set on cash, skip this step and focus on investments instead.
There are two ways to pay yourself first:
- Split your direct deposit between your checking account and savings account (ask your HR manager for the form).
- Set up an automatic transfer between your checking account and savings account on the day after you are paid. Any online savings account will make this easy.
Put your bills on autopilot.
In part one of this series, I talked about your “nut”, the fixed monthly expenses like rent, insurance, and student loan payments, that you pay every month in the same amount. Once you have a comfortable bank account buffer™ in place, the next step in putting your money on autopilot is to setup automatic bill payments to each of these bills. There are different ways to do this, and I rank them in order of my preference.
- Pay with a rewards credit card.
- Pay with your banks online billpay.
- Pay through an automatic bank draft (ACH).
Let’s talk about the options:
Credit Cards. Some billers like insurance, cable, and cell phones let you pay with a credit card. As long as they don’t charge a convenience fee to do so, this is your best bet. For one, you can earn your one or two percent of the bill back in rewards and two, you have a third party in between you and the biller. (Remember one of the best things about paying with a credit card—not cash check or debit card—is your right to dispute the payment with the credit card company and not pay a dime until that dispute is resolved).
Online Billpay. The next best option is setting up a recurring payment through your bank’s online billpay service. I like this option because you have control over multiple bills in one place (your bank’s online login). You can stop or change payments to more than one bill instantly in one place. For help finding the best online bank account read my Banking Tips and Reviews.
Autodraft/ACH. Traditionally, if you wanted to pay a recurring bill automatically, you have to sign up with the biller, give them your checking account and routing number, and let them automatically withdraw the bill amount from your checking account each month. This is fine, but there are some concerns:
- Redundant Maintenance. You must maintain your autopay with each biller individually. If you change banks, for example, you have to remember to change the accounts at each biller.
- Less Control. Let’s say you accidentally rack up $3,000 of data roaming charges on your phone while travelling abroad. Since you’re travelling, you forget to check your bill before the autodraft goes through. Your cell provider withdraws the $3k from your checking account and overdraws the account. Not only are you out that money and responsible for overdraft fees, you may lose your ability to negotiate the charges down (after all, the cell company already has your money).
- Returned Payments. If you have your checking account to reject overdrafts, your auto payment will be returned if you don’t have enough money in the bank at the time it’s processed. This may trigger a returned payment fee in addition to late fees from the biller. (Also, be sure to enter your checking account numbers correctly when you enroll at the biller’s Website. You payment will be returned if you make a typo, too.)
Put your investments on autopilot.
Once you have your savings and bills on autopilot, the last (but I would argue most important) step is to set up automatic investing. We will cover this in detail in part four of this series.
Don’t put your subscriptions on autopilot
Putting important payments that need to be paid on autopilot is entirely to your benefit, but subscriptions like Netflix, Hulu, and even your gym that you can now sign up for with a few clicks online, have a way of draining money from your bank account if you stop using them and forget to cancel the subscription.
If you’re one of the many that already have your subscriptions on auto and just can’t will yourself to sit down and go through and cancel them, Trim can help!
Trim is a free service that uses your credit card and bank transactions to inform you of long-forgotten subscriptions. Trim has you link your bank and credit card info to their service, but only loads the transactions related to subscriptions. They then send you a text message with all your subscriptions and you can cancel them by replying with “Cancel [insert subscriptions here].”
Trim even provides services such as sending your gym a certified letter telling them you aren’t coming anymore.
We humans are emotional, easily tempted, and lazy. We do stupid stuff with money. Therefore, it’s my opinion that the single most important thing you can do for your finances is to put your money on autopilot. Start by transferring a percentage of your income to a savings account as soon as you get paid. Then, setup all of your bills to be paid automatically by their due date either by credit card, bank bill pay, or ACH autodraft. Next time, we’ll talk about the final piece of the puzzle: establishing an automatic investment plan.
- Pay yourself first. If you haven’t already, open a separate high-yield savings account and set up an automatic transfer or split direct deposit to correspond with every payday. Do this even if you can only afford to save $20 a paycheck. You can increase the amount later. Having the system in place is what matters.
- Ensure you have a bank account buffer™. Do not proceed to action item three until you have this in place.
- Put your bills on autopilot. With a bank account buffer™ in place, put all of your monthly bills on autopay. Set aside an hour to set this up tonight and you’ll easily save an hour a month for the rest of your life.
Join The Discussion: How do you put your money on autopilot? What’s your system? Let us know in a comment.