This week we’re going to be talking about putting your finances on auto-pilot. We all procrastinate on important decisions, and when those decisions have to be made regularly, such as how much to put aside each month for our future, they end up getting left altogether. The answer is to automate as much as possible to remove that decision making.
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I love automating things. Having things done for me, with very little or no input from me is the ideal scenario in my book.
I’ve talked enough in the past about how important it is to keep an eye on your finances going forward, but still, there is much that can be removed from your immediate consciousness without jeopardising your future. In fact, putting these things on autopilot will have a positive impact going forward.
Everything you need to KNOW
1 – Multiple decisions lead to inertia
Plenty of research has shown that if you increase available choices decisions become harder to make. This is also anecdotally true. When you go to a great restaurant and see a fantastic menu of options, it can take a long time to decide. It’s the agony of choice!
Decisions take up valuable mental energy. We’re computing the benefit of choosing one option while assessing the opportunity cost of not choosing the others.
We make millions of small decisions each day – what to wear, which route to take, what to say in this particular moment. All this places a strain on your psyche, so I reckon we need to make as many things as easy as possible – I reckon!
Key financial decisions, such as when and how much to save and how to invest are decisions best left to autopilot.
2 – Relying on willpower is a flawed option
When saving and investing for the future, you’re buying a future promise, not a shiny gadget you can hold right here and now. This means that the here and now often wins out over the someday.
But that’s no way to win in the long term
Most of us don’t have the willpower to stick at something for the long term, or maybe it’s just me! I’m pretty sure it’s not just me, so for those of us with less willpower, automation takes away the need to exercise it, for the most part.
I’ve said it before, but saving ‘whatever is left’ at the end of the month is a nonsense. Parkinson’s law says that work expands to fill the time available. The financial version of this law says that expenditure rises to meet income.
In other words, there’ll never be anything left except once in a blue moon. And then you’ll be so pleased with yourself that you’ll go on a night out and celebrate, blowing the lot! Or again, maybe that’s just me!
Anyway – why rely on flawed willpower when you can setup a system to save for you?
Let’s look at how to do that now…
Everything you need to DO
1 – Embrace the idea of pay yourself first
I first heard the idea of paying yourself first in The Automatic Millionaire by David Bach which is only available on Kindle now but a great read. It is also on Audible audiobook and is read by the author.
The principle is as simple as its name: Pay yourself first before anyone else.
In practice this means you should put money aside at the start of the month just after you have been paid, and not at the end, for the reasons just mentioned.
If you are in debt, then these payments should go out first. Even though you’re technically paying someone else, you have to do it anyway, so maximise it to reduce the debt as quickly as possible. By reducing debt, you’re increasing your own net worth with every payment you make.
More on how to get out of debt waaaaay back in Session 4
2 – Determine your savings level
How much should you be saving for your future?
There’s no right answer to this. The later you have left it, the more you should save, of course.
For reference, I’m currently saving 16% of my net income. This is doable for me right now, but I’m determined to get it to 25% in the next year or so.
Once you have determined an affordable yet stretching savings level, you need to determine how much of your savings should be going to short, medium and long-term plans.
Here’s my breakdown:
- Long-term: 6%
- Medium term, 5-10 years: 2.5%
- Short-term, 1-5 years: 7.5%
Now, if you have no emergency fund or if you’re still building it, you should divert your savings money to this until it is done. What does ‘done’ mean? I would say three to six months’ net income put away but easily accessible should you need it.
For us, our short-term savings are basically savings towards Christmas. We put aside an amount each month so Christmas is paid for when we get to it.
Our medium term goals are holidays, a new car and a university fund for my daughters, the eldest of which will go to university in three years.
Our long-term savings are basically contributions to pensions.
You’ll need to determine your own split according to your own priorities. No-one can do this for you. It depends on what stage of life you’re in and your existing situation.
3 – Set automatic savings payments
The day after you get paid, set up payments to go to your various savings accounts in the right proportions you decided in the last step.
Make it easy for yourself by using the two (or more) account system I cover in detail in the Meaningful University course Learn How To Budget.
Essentially this means you get paid into one account, and all of your savings and regular direct debit bills come out of that account.
The balance which is left after all this is paid into another current account which is your spending account. This is what you have to budget, the rest looks after itself.
Process is simple:
- get paid
- pay into savings accounts
- leave enough in that account to pay all the rest of your fixed monthly bills
- transfer the balance into another spending account
- budget this account knowing your savings have already been made without you having to lift a finger.
Most likely, the amounts don’t change that much month to month so it should be a simple job each month to check that all is in order.
But what if you’re paid other than monthly?
The principle is the same, but you might find it helpful to stagger your bill payments throughout the month. Call your utility companies and loan companies to set up payments after each weekly or fortnightly payment.
It takes a little bit more planning and organising but the principle is no different.
What if you’re paid irregularly? For example maybe you earn commission, or part of your income is made up of overtime, which varies from month to month.
You need to go all out to get a buffer account in place. Try to establish a baseline expenditure amount by adding up your food, fuel, utilities, debt repayments. Add this together and multiply it by three
This is what you need in your bills account to smooth out the bad months. Make sure always to top it back up on the good months. Again, a little bit of extra planning work at the top of the month and you’re good to go.
These are the core things that will force you to save each month no matter what, but what else can you do?
4 – Set up other automation
Once the money leaves your account, there are other things that can be automated:
Make sure your investment accounts and pensions are set to auto-invest. Most are, but not all. You don’t want money accumulating in cash earning nothing because you have forgotten to place this month’s trades.
You should be able to set your desired investment strategy at outset, and then each payment will be invested accordingly.
Make sure your investments will auto-rebalance. It depends on how hands-on you want to be, but if you really want to put things on autopilot, you want your system running whether you remember to act or not.
Rebalancing is the action of putting an investment portfolio back into the balance it had when you first started out
For example if you invest £10,000 two ways, £5,000 into shares and £5,000 into bonds. Over a year, the equities double in value and the bonds halve. Now you have a £12,500 portfolio, which is skewed £10,000 into shares and £2,500 into bonds.
What happens now if equities tank? Disaster. You’re holding too much in shares and if they go down, too large a proportion of your portfolio goes down too.
You must get into the habit of rebalancing at regular intervals. Annually is probably enough for most people, but you can go quarterly if you prefer, and you can set your investing platform to do this for you so you don’t have to remember. Do beware of trading costs, but most platforms don’t charge as long as you are using funds, not direct shareholdings.
Set your regular savings contributions to index each year. This automatic increase makes sure you don’t leave your contributions stagnant for any length of time. They’ll increase steadily by inflation or a set amount, and the difference that’ll make to your eventual wealth is significant.
So you see, there are lots of things you can do to put your finances on auto-pilot, and once they are set up, they’ll only need occasional checkups to make sure everything is running smoothly.
Don’t forget, a full transcript of this entire episode is available if you hit the button below:
Meaningful University – Learn How To Budget
Session 4 – Five steps to get out of debt
Thanks to lavinia from the USA, Synergy82 from Romania, Dpeddler and MKLondon from the UK for their reviews.
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Next Session Announcement
Next time I’ll be talking again to Damien Fahy from Money To The Masses about his new service, The 80:20 Investor.
If you have any financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/askpete