Saving Strategies

By Financial Advisor Peter Egolf

How do you actually reach your saving and financial goals?

I set out to write an article about the behavioral biases that make saving and reaching financial goals challenging, but I woke up this morning to find that fellow Queen’s University alumnus, Dr. Peter Attia, beat me to it. I recommend reading his article for an excellent refresher on hyperbolic discounting and the human biases that pin our present self against our future self.¹

The following text will serve as a complement, outlining strategic roadmaps for saving and reaching your financial goals.

So how do you reach your financial goals? Money! But is money alone enough? It is if you have enough of it. But even still, money has risks. The prominent and pervasive risk is inflation, also known as the reduced purchasing power of the money under your mattress over time. For example, $100 from last year buys only about $93 of goods today² due to the effects of near 7% inflation. Therefore, how can you preserve and grow your money? One option is to invest it.

Investing is a two-part equation. The first part starts with money. You need money to invest. The second part is that your investment (e.g., stock or bond) needs to produce returns.

Thus, investors need a strategy to increase their saving rates and investment returns to reach and maintain their financial goals. Most of our articles are dedicated to investing, so let’s look more closely at the strategy’s overlooked and under-optimized saving portion.

What saving strategies can overcome these behavioral biases to reach your financial goals as a fallible human?

Strategy 1 - Save More Tomorrow³

• Step 1: Commit to saving more in the future.
• Step 2: Increase saving rate with future income raises.
• Step 3: Make it difficult to stop.

This strategy was designed by Richard Thaler, one of the preeminent behavioral economists, and provides a high-level saving strategy based around:

• pre-commitment (setting a saving amount/rate)
• minimizing loss aversion (never decreasing your take-home pay)
• using inertia to your advantage (having to opt-out reinforces commitment)

This strategy provides a solid framework, but it can be more effective with additional elements.

Strategy 2 - Pay Yourself First

Paying Yourself First uses the same logic as Save More Tomorrow but directs your income into investment saving before it even reaches your bank account. This is beneficial for a few reasons.

1. You prevent loss aversion by never actually “having” this money in your possession as it is transferred from your employer directly to your investment accounts.
2. You avoid having to make any choice after the initial saving amount commitment.
3. You can even pre-commit to increasing your saving rate as your salary/income increases.

The beauty of this saving solution is that it makes saving easy, really easy. It takes one initial choice that can be customized to meet your needs. It avoids paradox of choice, choice overload, inertia, and other mental barriers and weaknesses that make saving difficult.

Strategy 3 - Pay Yourself First with Rewards

While Paying Yourself First is fun in the sense that you avoid destructive behaviors, it can be turbocharged (or supercharged if you prefer whine over whoosh) with a simultaneous reward. The evidence is clear that long-term positive behavior can be reinforced via immediate rewards, even non-monetary rewards. Here is an example.

You set up Pay Yourself First by having $1,000 from your paycheck contributed into your brokerage investment account. Additionally, you commit to proportionately increasing your saving amount to your new income level at each future pay raise. However, you realize that this isn’t as fun as it can be, so you decide that at each pay period:

• You will treat yourself to something you genuinely enjoy. This rewards yourself for your Paying Yourself First (e.g., rewarding yourself with lunch at your favorite spot, doing a particular activity like a hike, visiting a new place, etc.), or
• Create a competition with your friends or family to maximize the social pressure to maintain and increase your saving rate.

Thus, you train yourself to seek the reward, not the action. It is, ideally, decoupling both. This is why you train a dog with treats. You want the dog to learn the behavior by doing an activity that results in the reward they seek, not punishing them for not doing the desired behavior. For humans, it is the same, get a reward (treat) by saving (action).

This system is Medium Maximization, aka Gamification. Researchers showed that “[…] that when people are faced with options entailing different outcomes, the presence of a medium (reward) can alter what option they choose. This effect occurs because the medium presents an illusion of advantage to an otherwise not so advantageous option, an illusion of certainty to an otherwise uncertain option, or an illusion of linearity to an otherwise concave effort-outcome return relationship.”⁴

Through gamification, rewards can support good financial behaviors⁵ or destructive financial behaviors.⁶ The key is to understand what motivates you and design a system around it. The reward through gamification can be whatever you want, as long as it isn’t wholly negating the saving monetarily. Apps with point systems or credits use this logic, engaging users to complete behaviors.

At One Day In July, we design these saving systems to help keep our clients accountable and to help them reach their financial goals. Whether you want saving to be fun or serious, we will help you design and customize your personal saving plan.

¹ Peter Attia MD - Hyperbolic discounting: friend and foe of goal achievement February 13, 2022
² February 13, 2022
³ Save More Tomorrow
⁴ Medium Maximization
⁵ Bloomberg: The Gamification of Finance May Be a Good Thing After All
⁶ Wired: How Robinhood's Psych Experiment Backfired Horribly