For many families saving money can be like trying to fill a leaky bucket. No matter how much water you pour in, it always seems to leak out. Or worse still, you forget to put the water in altogether.
To be sure there are some real barriers to saving, but there is also a solution.
An automatic savings plan is a way to set up regular, automatic transfers from your checking account to your savings or investment account. This can be a convenient and effective way to save money consistently, as the transfers happen automatically, so you don't have to remember to transfer the money yourself.
There are several benefits to setting up an automatic savings plan:
- Consistent savings: One of the biggest benefits of an automatic savings plan is that it helps you to save consistently, even if you don't have a lot of extra money to put into savings. By transferring a small amount of money each month, for example, you can gradually build up your savings over time.
- Easier to stick to a budget: An automatic savings plan can also make it easier to stick to a budget since you can plan your spending around the money that is left in your checking account after the automatic transfer. This can help you to avoid overspending and keep your finances on track. It also works with kakeibo.
- Easy to set up: Setting up an automatic savings plan is typically easy to do, and can often be done through your bank's online or mobile banking app, or by contacting your bank directly. All you need is a savings account set up at a bank or credit union, and you can choose how much money you want to transfer each month and how often you want the transfers to occur. Oh, and this works for many investment accounts too.
- Motivation to save: Finally, an automatic savings plan can be a great way to stay motivated to save. By setting a specific savings goal in mind, such as saving for a down payment on a home, an emergency fund, or a retirement account, you can stay focused on your financial goals and see your progress over time.
Enemies You May Face
In addition to the four benefits of automatic savings, having your savings or investing happen programmatically can help overcome some of the most common barriers to saving money. These barriers —which we can think of as money-saving enemies— include:
- Instant gratification: Many people struggle with the desire to have immediate gratification, which can make it hard to resist the temptation to spend money on immediate pleasures rather than saving for the future. Our forefathers used to take pride in delaying gratification, but now our culture urges us to consume right now.
- Lack of motivation: Some people may not see the value in saving money or may not have a clear financial goal in mind, which can make it difficult to motivate themselves to save.
- Procrastination: Some people may put off saving money because they feel overwhelmed or intimidated by the process, or because they believe they do not have enough money to make a difference.
- Limited income: For people living on a low income or with high expenses, it can be challenging to find money to save. It might feel like even giving up a few dollars each week takes food directly off of the table.
Automatic saving helps us overcome many of these challenges because we don't have to actively put the money away. It just happens and is often unnoticed.
To set up an automatic savings plan, follow these steps:
- Choose a savings account: First, you'll need to have a savings account set up at a bank or credit union. If you don't already have one, you can shop around to find the best savings account for your needs. Look for an account that offers a competitive interest rate and low fees.
- Decide how much to save: Next, you'll need to decide how much money you want to transfer to your savings account each month, and how often you want the transfers to occur. It's a good idea to start small, perhaps by transferring $50 or $100 each month. As you get more comfortable with saving, you can gradually increase the amount you transfer.
- Set up the automatic transfer: Once you've chosen your savings account and decided how much to save, you can set up the automatic transfer through your bank's online or mobile banking app, or by contacting your bank directly. Most banks make it easy to set up automatic transfers, and you can usually choose how often you want the transfers to occur, such as every week, every two weeks, or every month.
- Review and adjust your plan: After you've set up your automatic savings plan, it's a good idea to review it periodically to make sure it's still meeting your needs. If you're able to save more money, consider increasing the amount you transfer each month. On the other hand, if you're struggling to save, you may need to reduce the amount you transfer or adjust your budget to make room for saving.
- Monitor your progress: As you save money with your automatic savings plan, be sure to monitor your progress and celebrate your successes. Seeing your savings grow can be a great motivator to keep going, and it can help you to stay on track with your financial goals.
Let's consider an example of how much money someone could put aside. Here we are assuming that you set up a $25 per week deposit into a savings account that has an annual percentage yield (APY) of 3.75 percent.
To calculate the savings for each year, we used this formula.
Savings = principal * (1 + rate/n)^(n*t)
- principal is the initial amount of money saved
- rate is the annual percentage yield (APY) of the savings account
- n is the number of times the interest is compounded per year (52 in this case, since the savings plan is set up to transfer $25 per week)
- t is the number of years the money is saved
Using this formula, we can see that after five years, a person who saves $25 per week in a savings account yielding 3.75 percent APY would have a total of $6,586 in savings.
The steps are similar if you want to put your money in an investment account rather than a savings account.
- Choose an investment account: The first step in setting up automatic contributions to an investment account is to choose the type of investment account that best meets your financial goals and risk tolerance. Options include individual brokerage accounts, employer-sponsored retirement accounts (such as 401(k)s), and individual retirement accounts (such as Roth IRAs or traditional IRAs).
- Open the account: Once you have chosen the type of investment account that you want to use, you will need to open the account. This typically involves filling out an application and providing personal and financial information. You may also need to make an initial deposit to get started. This is, of course, becoming much easier as the number of investing apps increases.
- Choose your investments: Next, you will need to decide how you want to allocate your investment dollars. This may involve choosing individual stocks, mutual funds, or exchange-traded funds (ETFs), or using a robo-advisor to create a diversified portfolio for you.
- Set up automatic contributions: Once you have chosen your investments, you can set up automatic contributions to your investment account. This typically involves specifying the amount of money you want to contribute and the frequency of the contributions (e.g., weekly, biweekly, monthly). You may also need to set up a method for transferring the money from your bank account to your investment account.
- Review and adjust your investments as needed: After you have set up your automatic contributions, it is important to periodically review your investments and make any necessary adjustments. This may involve rebalancing your portfolio to maintain your desired asset allocation, or making changes to your investments based on your financial goals or changing market conditions.
Let's consider another scenario. But first we need to pick an investment, like index funds. For the ten years leading up to 2021, the top three American index funds all turned an average return higher than even the best savings accounts.
|Average Annual Return
Now, lets imagine that you invested $25 per week in the S&P 500 at a 13.5 percent average return.
Saving vs. Investing
Whether it is better to put the funds from an automatic savings plan in a savings account or an investment account depends on your individual financial goals and risk tolerance.
Savings accounts are a relatively low-risk way to save money, as they are FDIC-insured and offer a relatively low, but stable, return on investment. They are a good option for people who are saving for short-term goals or who want to have easy access to their money without worrying about market fluctuations.
Investing, on the other hand, can potentially offer higher returns over the long term, but it also carries greater risk. Investing involves putting your money into assets such as stocks, bonds, or mutual funds, which can fluctuate in value and may not always provide a positive return. Investing is a good option for people who are saving for long-term goals and who are willing to accept a higher level of risk in exchange for the potential for higher returns.
When deciding whether to put the funds from an automatic savings plan in a savings account or to invest it, it is important to consider your financial goals, risk tolerance, and time horizon. If you are saving for a short-term goal or want a low-risk option, a savings account may be a good choice. If you are saving for a long-term goal and are willing to accept a higher level of risk, investing may be a better option. It is also a good idea to seek the advice of a financial planner or advisor if you are unsure which option is right for you.
An Automatic Millionaire
A saving habit is one of the ways you and your family can build wealth. And for me personally, this idea really came home, if you will, after I read David Bach's superb 2004 book, The Automatic Millionaire: A Powerful One-step Plan to Live and Finish Rich.
The book focuses on the concept of automating one's finances in order to build wealth over time. It advocates for setting up automatic savings and investing plans, as well as making other financial decisions that can help to build wealth automatically, rather than relying on conscious effort and discipline.
The book offers practical advice and strategies for building wealth, including setting financial goals, creating a budget, paying off debt, and investing for the long term. It also includes case studies and real-life examples to illustrate the principles and strategies discussed in the book.
Reading it is a good next step in if you are interested in wealth automation.