Recently I’ve found myself really struggling with the lack of progress I’m making in certain areas of my life. Up until a couple of months ago, I was used to creating a to-do list and then locking myself away or staying up late to make sure I got it done. I lived by those lists.
After my son Henry was born, I was in for a rude awakening. I remember confidently telling people, “I’ll work when the baby naps.” I planned to make my to-do list and run through it just like before because babies are notoriously easy tempered and take consistent, long naps.
A few weeks ago I was thinking about how frustrated I was that I couldn’t do anything. I’d have a big task that I really wanted to get done and I couldn’t get it done because now I had a baby that demanded 95% of my attention.
I was nearing a breaking point when I remembered the advice I’d heard years ago to just try and do 1% better every day. I wasn’t going to wake up tomorrow completely different with a baby that slept at regular intervals and let me work uninterrupted for hours at a time. That’s not realistic. But it is realistic to think that I can do 1% more each day.
Since then, it’s been my mantra and has made every single day that much easier. I’m no longer making myself crazy by setting an unattainable goal – I’m simply focusing on doing better 1% at a time.
Incremental changes are much easier than making one giant leap.
Making changes to your money shouldn’t be any different.
So…how does this make you smarter with money?
During business school, one of my favorite classes was behavioral economics: understanding the effect that psychology and emotions play into decision making.
If we were all rational humans we’d all be fit, save an appropriate amount each month, invest our money without letting emotions like fear stand in our way.
But we’re not perfect. I mean, at least I’m not.
That’s where behavioral economics comes in. We’re told to save at least 20% for retirement. To put money into our investments and not make irrational decisions like selling when the market drops. In theory that sounds great. We know what to do, we just don’t know how to make ourselves do it.
Behavioral economics bridges that gap. It looks at how psychology can be used to nudge us to make better decisions.
This idea of doing 1% more or 1% better reminded me of a study run by behavioral economists Schlomo Benartzi and Richard Thaler to find a way to actually get people to save for retirement. Something we are notoriously bad at doing.
As we’ve all often heard, Americans are terrible at saving for retirement. Very few people have enough saved for retirement – in fact, 1 in 3 have nothing saved. Benartzi and Thaler created and tested a program called “Save More Tomorrow” to use behavioral finance to encourage employees to – you guessed it – save more tomorrow.
As part of the savings plan employees who were enrolled in their company retirement plan were invited to commit to automatically increase their contribution rate sometime in the future: either in a few months, on a specific date, or when they receive pay raises.
And it worked.
The first company to implement this plan saw employee savings rates increase from 3.5% to 13.6% in four years.
Why it works
Self-control is easier to accept if delayed rather than immediate
I can’t count the number of times I’ve promised that next week will be when I start going to the gym regularly. I’d never say that I’m going to start today, there are always too many reasons not to: my toe kind of hurts, I’m hungry, I’d rather go home and clean, etc. But next week? That’s looking easy. I’ll absolutely go to the gym next week (but seriously, I am going to start next week).
The same thing happens here. This month is a little too difficult to save more but in a few months? Sure, why not bump up your savings by 1%. It sounds much easier to do when you plan to do it in the future.
Once you’ve started something, it’s easier to continue doing something. The people in the plan were enrolled in these automatic escalations. It was easier for them to do nothing – to keep the automatic escalations going – rather than to cancel them.
Loss aversion can mess with you
How would you feel if you lost $100? What about if you won $100? Loss aversion means that we’re wired to hate losing money more than we are excited to win more of it.
By timing the savings rate increase – say from saving 10% of your take-home pay to saving 15% of your take-home pay – with a raise, you won’t be feeling emotionally distraught from your loss aversion; from losing out on that money that you could be spending.
How to apply it to your life (outside of your employer)
If you work for a company that offers auto-escalation on retirement plans, it’s a great thing to take advantage of.
But using this idea shouldn’t stop there. How else can you apply it to your life?
Create the same system that utilizes delayed self-control, inertia, and if possible, loss aversion. That’s just a fancy way to say:
Promise to save 1% more in the future, set up an automatic increase now, and time it with a raise, if you can.
If you’re already automatically transferring money to your savings or investment account, you can create scheduled increases every so often. Schedule a 1% increase in your savings rate to take place in 3 months. By deciding to make it in the future, you’re utilizing delayed self-control. By actually setting up the transfer, you’re using inertia (it’s easier to keep the transfer once it’s been set up than it is to go in and change it). If your company provides annual raises, time a larger escalation to coincide with a raise to avoid loss aversion.
For example, if you’re currently saving $500 a month, change that automatic transfer to go up to $550 in 3 months from now. If you have an automatic transfer to an investment account, change that automatic transfer to go up in a few months.
Jordan and I have been doing this for the past couple of years. Rather than creating big cuts or goals like “we need to save $X more this month!”, we’ll go in and change our transfer by a little bit every so often. It’s not a lot – probably just a few percentages each time. But that incremental change barely affects our lifestyle, but over time has significantly impacted our savings and investments.
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Erica Gellerman, CPA
Erica Gellerman is a CPA, MBA, personal finance writer, and founder of The Worth Project: a weekly money newsletter you actually want to read. Her work has been featured on Forbes, Money, Business Insider, The Everygirl, The Everymom, and Lifehacker. When she's not writing about personal finance you can find Erica exploring Europe from her temporary home base in London.