Personal finance is simple and it’s intuitive. Most people, if asked how they should handle their money, know they should spend less, save more, invest wisely and eliminate debt. Seriously, it’s that easy. So why aren’t we all successful at managing our finances?
I believe that the disconnect lies in the gap between knowing what to do and actually doing it. The hard part is finding the motivation to put it into action. This is because it goes against our natural inclinations and so it seems uncomfortable. It’s easier to go into debt and get the things we want immediately, rather than to wait and save up. The matter is complicated by the examples we see around us. Because money is a taboo subject in our society, most people don’t discuss how they pay for things or what they do with their money. If we don’t see people eliminating debt or saving for years, we only notice them spending large amounts and risk feeling jealousy. We easily rationalise that if they can spend so carelessly, so can we.
In order to succeed, we need to counter these natural tendencies. What can we do? The first step is to create a plan that really works. The plan will provide the logical decisions that fit the principles of personal finance. For example, in its simplest form, a personal financial plan may state: “Starting from my current assets, if I save $800 per month for eighteen years, I will have around $800,000. That should provide $40,000 per year after-tax income, which will provide for my needs in retirement, after pension income. At the same time, paying $300 per month toward debt will ensure the debt is paid off in ten years. The money I save will be invested 80% in the stock market, 20% in bonds, to provide the growth I need and a small amount of certainty.” This plan is very rational, it provides the required steps and the expected outcome. It could work, but only if it’s put into practice.
It would be very uncomfortable to go from spending all your income to diverting $1100 (in the example above) to savings and debt repayment. For that reason, most people will get to the end of the month, realise there’s very little money left (if any), and fail to make progress. One idea is to make the payments automatic. Trying to talk yourself out of spending is difficult. If the money is simply not there, the decision has already been made. If you are having difficulty saving, having money withheld from your paycheque or debited from your bank account on payday solves the problem for you. Many people notice that they barely miss the money that was withheld. The government knows this, which explains why income taxes are withheld from our paycheques. If you’re able to make a rational decision about saving, but not able to follow through and reduce spending enough to save money, try making it automatic.
Another option is to find examples of the behaviour you want to have. A good example is RRSP contributions. In the late 1970s, very few people contributed to an RRSP. The tax incentive had been introduced, but few people understood the program. Today, banks and other financial institutions have huge ad campaigns around “RRSP season.” It seems that everyone is contributing to an RRSP and many people feel guilty if they don’t contribute at least a portion. This makes it much easier to make the (otherwise uncomfortable) choice to save, because it feels like the default choice.
If you have tried both of the approaches above and not had any success, it may be time to revisit your plan. While it may make sense to retire with 80% of your pre-retirement income (a common rule of thumb), that may not be for you. The government and the financial industry have expressed concern that Canadians aren’t saving enough. But what if you’d rather retire somewhere with a much lower cost of living? Or what if you’d rather enjoy your money during your active, healthy years, knowing that longevity doesn’t run in your family? Everyone has different needs and no one should adopt a financial plan, just because it was presented by an expert. It needs to reflect your personal goals and values.
Personal finance is interesting in that it’s simple to know what to do, but that doesn’t automatically translate into financial success. Taking the steps that lead to success, including spending less, savings more and reducing debt feel uncomfortable, which causes some people to make choices contrary to their own plan for success. Taking steps to surround yourself with examples of the necessary actions and making those actions as automatic as possible helps to avoid the discomfort that otherwise might be experienced. If you are still not able to succeed, reexamine your goals and review whether or not they fit with your values. Maybe you would rather live for today and let the future worry about itself.