Editor's note: This article originally ran on Consumerism Commentary. It has been reprinted here with permission.
Last month, I wrote about the opinions of Scott Adams on his eventual success as the creator of the comic strip Dilbert. I focused on the failure aspect of the article he wrote for the Wall Street Journal, and I only touched lightly on the success factors. A system, a methodical way of approaching any particular effort, is one of the core components of success.
A household uses systems all the time. You may have a system for effective grocery shopping: Perhaps you keep a notepad and pen on the refrigerator, write down anything you need to purchase when stocks are low, take the list with you on your shopping day, and, for the most part, prevent yourself from veering from the list too much when you shop.
You might have a different system for grocery shopping: you may have an automatic shipment of groceries delivered to you from Amazon.com every two weeks, each time the same order.
If you read Consumerism Commentary regularly, it’s likely you have at least one system in place to improve your savings over the long-term. It’s a concept I’ve discussed many times over the past decade, and it’s such a basic piece of financial advice that you’ve no doubt heard of it even if you haven’t been reading my writing for long.
You must make your savings automatic. By creating a system that handles your savings automatically, you eliminate or greatly reduce the chance of not reaching your goals. It’s a technique that someone at any income level can put into practice. Having a bank account (or an account at a credit union) makes it easier because financial institutions have technology that assists in this approach to money management.
Every once in a while, if you read about money management, you might come across a rule of thumb. “You should save 10 percent of your income” is one such common refrain. You can look at this either as a position to start or as a goal that might take some time to accomplish due to other factors. Even starting a savings system with 1 or 2 percent of your income is better than haphazardly setting money aside.
Direct deposit of your pay.
The fewer hands that touch your money from the moment you receive it to the moment it is used, the better. Most modern employers offer direct deposit. Rather than receiving a paper check, you provide your banking information to the employer and the company sends an electronic payment directly to your bank. In most cases, you receive your pay as much as a business day sooner, so you have the opportunity to pay bills or collect interest faster.
More companies are offering employee pay in the form of debit cards. For employees without bank accounts, this may be slightly better than having those employees use expensive check-cashing storefronts to access cash. But when compared to direct deposit, this is a horrible idea that will likely have adverse effects on the employee’s ability to build savings from their income over the long-term.
Sign up for direct deposit, and if your employer doesn’t offer it, encourage your boss to consider it. Direct deposit is the best system for keeping more of your income.
Automatic bank transfers.
Almost every bank with which I’ve had an account — and that number is likely around forty — has some method of creating automatic transfers.
Here’s an example from Wells Fargo. When you sign in, the option to schedule an automatic transfer is one of the primary options in the menu. With your income directly deposited into your checking account, and with a savings account earning at least a little bit of interest, you can create a savings system that you set once and forget about. After a few weeks of regular transfers completed behind the scenes by the bank’s software, you won’t even notice the money isn’t in your checking account.
But a brick-and-mortar bank might not be the best option for savings. Sometimes your checking and savings accounts will be at two separate banks. In fact, often it’s better to separate these accounts so you can keep your savings in a bank that you’re not tempted to visit every day, like an online bank. Online banks often offer better interest rates, anyway. Over the last few years, the lines between online banks and brick and mortar banks have blurred. More traditional financial institutions are offering accounts you can only use online, for example. Here are some of my recommendations for savings accounts with the highest interest rates.
With Capital One 360, you can link your profile to an external bank account, like the Wells Fargo account I used in the example. This is my actual set-up, although my income is in a business account, not a personal account. Just like with Wells Fargo, you can use Capital One 360 to schedule a transfer; in this case, it would be an automatic transfer between the Wells Fargo checking account that is used for direct deposit and the savings account at Capital One 360 with the higher interest rate than the Wells Fargo savings account.
A few years ago, Bank of America introduced a “Keep The Change” program to its customers. Here’s how this worked. Every time you made a purchase with your debit card, Bank of America would round the transaction up to the nearest dollar and transfer the remainder into your Bank of America savings account.
Now the bank’s savings account earned paltry interest compared to some other banks, but this systematic savings could be substantial. It’s like the coin jar at home. At the end of the day, when you take the change out of your pocket and place it in your coin jar, you’re saving your remainders. As more people moved away from cash transactions towards plastic — credit cards and debit cards — the coin jar doesn’t receive as much attention as it used to.
This, despite all the problems with Bank of America, was a clever extension of the coin jar metaphor into the digital age. Keep in mind, though, any interest you earn on savings in a bank account can be easily negated by account maintenance fees. especially if your savings isn’t large enough to produce interest that outweighs those fees.
Last month, I was introduced to a start-up company in the financial industry called SavedPlus. This is a service that can help automate your savings based on your spending rather than your income. With SavedPlus, you link your primary spending, checking and savings accounts to the service. It’s a read-only connection; SavedPlus can’t change or otherwise affect the linked accounts. Every time you spend money, SavedPlus will initiate a transfer from your checking account to your savings account. It works across any combination of banks.
The amount of the transfer is based on the savings rate you determine. Mine is set at 10 percent.
I have my primary credit card linked to SavedPlus, so for each transaction that falls within a certain range, SavedPlus will transfer 10 percent of that transaction to my savings. The service has some protections; SavedPlus will not initiate a transfer if your account balance is too low or if your purchase is too high, based on parameters you determine.
The service is still new, and I am finding myself with a few questions, but it might be worth some experimentation.
There’s a drawback to automatic savings. The advantage of creating this system for saving money can also create a money management problem. Once you stop actively making one particular decision with your income each pay period, it’s easy to forget what you’re doing and why you’re doing it. You need to continue to look at your financial status on a regular basis, just like we do on Consumerism Commentary with Naked With Cash. Frequently evaluate whether the choices you made and set into motion with an automatic system continue to be the best options for you.
If you start saving 2 percent of your income but your situation changes, have you increased your savings rate? Can you get to 10 percent two years after starting your system? If you have been saving 10 percent and don’t feel any stress, is it safe to move to a 20 percent rate of savings? Once your system is a natural piece of your process, so much so that it is invisible to you, you could be giving up some control or awareness of your financial situation.
Personal finance is about making conscious choices with your money. That includes not using money without considering the circumstances. The present scenario changes over time, and a system does not relieve you of the need to see every pay check as a money-saving opportunity.
Automatic saving leads to success. A study from 2009 (Gordon, Romich, & Waithaka) determined that customers who created systems in the form of automatic savings transfers had more success accumulating savings. The accumulation savings is an intermediate goal, meaning it’s part of a path towards something else. With more savings, you can avoid expensive debt, and you can reach financial independence sooner. This gives you the ability to have more control over your life, to spend your time doing what makes you happy without having to be concerned about negative financial consequences for every decision you make.
Systems like automatic savings will help get you there.
How do you automate your savings?
Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991.