Summer is here. Wouldn’t it be nice to have a vacation fund all saved up to go somewhere great? Sure, but most of us don’t. In fact, the Federal Reserve says 40% of Americans don’t even have $400 to cover an emergency expense.
If you’re not good at saving, it’s not your fault. Our brains are not wired to focus on the future, so you are fighting against millions of years of evolution. The good news is that there’s a simple way to win this fight: Make it automatic.
“The right way to do it is the easy way to do it,” says Brigitte Madrian, a behavioral economist and dean of the Marriott School of Business at Brigham Young University. “The easy way to do it is through payroll deduction, because the money you never see is the money that you’re much less likely to miss.”
Madrian says humans “tend to overweight how we feel in the present, our current situation, relative to what things could be like in the future.” We “discount the future,” putting more importance on the things that are right in front of us — meeting friends for drinks, for instance, or even doing the dishes — than saving now for something that is years or even decades away.
But, Madrian says, if we make saving automatic, we are very successful at it. And there is striking evidence that it actually works.
“Much more successful than we thought”
The U.K. government over the past decade has been phasing in a law that requires employers to enroll the entire working population into a retirement savings program. Even if you flip burgers at McDonald’s, your employer has to enroll you in an automatic savings plan.
Every one of the 1.2 million employers in the U.K. has to participate, says Charlotte Clark, director of the program for the U.K. government. She says the program started with employees saving 2% of their salary. Over the past year, the program bumped the share to 5%, with the employer kicking in a portion.
Employees can opt out if they want. So how many people are able to stick with this savings program? More than 90%, says Clark.
“It’s been much more successful than we thought,” Clark says.
It might seem counterintuitive that many people, even those with lower incomes, are able to keep saving. Many people live paycheck to paycheck, without much financial wiggle room.
“But what’s also true [for those who don’t save] is that many of those households that are living on the edge end up having to turn to expensive forms of credit when they get hit by financial shocks,” Madrian says.
A car repair often gets put on a credit card with a high interest rate. That costs a lot more money and is less affordable than learning how to get better at saving the money before you need to spend it.
In fact, Clark says, people on lower incomes actually have a higher likelihood of sticking with the savings program, because they like watching these savings build up.
“We didn’t think, if you did it across the whole of the population, you’d end up with that sort of number,” Clark says. “I think my view is, defaults are really powerful.
Free money you don’t want to pass up
You don’t have to live in the U.K. to employ this powerful life hack. “You should absolutely be participating in your 401(k)” if your employer offers one, Madrian says, “because you can sign up once and you can just leave it alone.”
Studies in the U.S. by Madrian and other economists have found that, just as in the U.K., the vast majority of people stick with saving money in a retirement plan once they are enrolled. In Madrian’s study, however, far fewer signed up for the very same retirement savings plan if they had to do it themselves.
Some employers in the U.S. now enroll workers automatically, the same way the U.K. requires. That method is especially powerful because it employs two levels of automatic saving: auto-enrollment in the plan and auto-deduction from paychecks.
Madrian says that if your employer offers to match funds you put into a 401(k), that’s free money that you don’t want to pass up. Also, the wages that you squirrel away in retirement accounts like 401(k) plans and IRAs reduce the amount of taxes you’ll have to pay at the end of the year too.
Madrian recommends ramping up your savings over several years, even by as little as 2 percentage points a year. “Within a few years, you can get a large fraction of people who started out saving 3 or 4% a year up to 10, 11, 12% a year, and they haven’t even noticed it,” she says.
If your employer doesn’t offer a retirement plan, you can set up your own account and direct your employer to auto-deposit part of every paycheck into it, or you can make a recurring automatic payment from your checking account. (We have an entire Life Kit episode on how to set up a smart retirement investment account and avoid paying excessive fees.)
Personal finance experts also say it’s a good idea to send money into multiple accounts — one for retirement that you never touch; another for expenses that pop up, like car repairs or a broken washing machine; a college savings fund if you have children; and one to save for vacations or other fun nonessentials. Experts advise that when you save for emergencies, find an account that doesn’t charge fees — those can quickly put a dent in savings.
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