Nick Murray, one of the most prolific scholars in our industry, states in his book Behavioral Investment Counseling that “your family’s financial well-being in later life, and its ability to leave significant legacies to its children, will depend largely on what percentage of its income it manages to save – perhaps the ultimate behavioral variable.”
If Nick Murray is right – that the most important factor in a financial plan is the percentage of income saved – we would do well to listen. Now, to be clear, the purpose of this article is not to promote higher savings percentages. The purpose of this article is to discuss the single most important phrase in the quote above: “manages to save.” How do we maximize efficiency in savings? Better yet, how do we make sure savings actually happen? My suggestion is to automate everything (or at least what you can).
Most online banks and investing platforms offer an option to set up electronic one-time or recurring automatic contributions. The institution simply requests information on your checking or savings account and withdraws the money automatically on the date(s) specified.
Because of the power of compound interest and time value of money (read more about this in Bryan’s most recent article), the earlier you start saving the better. $100,000 saved now growing at an annual interest rate of 7% will be worth $542,743 in 25 years, as opposed to $196,715 in 10 years. Add an extra $250 dollars a month and the 25-year ending value goes to $776,241. Coupled with inflation and the need for financial capital upon retirement, adequate savings and portfolio growth is necessary for a successful financial plan.
For many of you, I am preaching to the choir. You have set up automatic savings and trust time, and the power of the markets, to build your portfolio. For others, I would ask you to consider the following points for why you should automate your savings.
- Destroy confusion over market timing
How often have you thought or heard the statement, “the market seems too high to invest my money right now?” With the S&P 500 currently trading at a price well over 4 times the lowest point of the Great Recession and near its all-time closing high of 3,025.86, I understand why this fear exists. Yet, history would show that playing this game is risky. First, if you always played this game, you might have never invested at all. At any point in the market’s history an argument could be made (and probably was) for why it was a bad time to invest. Whether because the market was “too high”, or because it was trending downward, the claim could be made: “now is not the right time.”
The chart below does a great job illustrating the harm of missing out on market growth. If you missed the 15 best days of the market from 1990-2017, your return would have been 6.18% compared to the market’s 9.81% (a 37% reduction). Miss the 25 best single days and you’re getting close to the average return of short-term U.S. Treasuries!
Timing the market is difficult, if not impossible to do. However, the consequences for missing out on growth can be quite substantial over time. Saving dollars on your own terms may add unnecessary temptation to time the markets. Automatic recurring contributions are not concerned about your feelings or the status of the current market environment. They occur faithfully at the specified interval over and over. As time passes, these contributions build, grow with the market, and lay the foundation for a successful financial plan.
- Eliminate psychological stress
There’s value to relieving yourself of the task to manually save dollars each month. First, by trying to manually save, you run the risk of forgetting. Second, you bear the burden of having to willingly “let go” of dollars month after month. This can prove to be psychologically taxing, even if you don’t realize it.
In his book, The Power of Habit: Why We Do What We Do in Life and Business, Charles Duhigg says, “Willpower isn’t just a skill. It’s a muscle, like the muscles in your arms or legs, and it gets tired as it works harder, so there’s less power left over for other things.” We know that saving dollars consistently, over a long period of time is imperative to the solvency of almost every financial plan. However, savings doesn’t have to be contingent on your will-power or ability to consistently complete a task. Automating contributions lifts this burden off your shoulders.
In the financial planning world, there is a commonly used phrase that says, “pay yourself first.” The meaning of this phrase is straightforward: as soon as you get paid, before paying for anything else (housing, groceries, bills, etc.), send money to your savings account(s). Failing to follow this principle results in the ongoing appeal to spend dollars in your bank account instead of saving them. Automatic savings protect you from yourself while, over time, bolstering the health of your financial plan.
It might be uncomfortable to see less dollars in your bank account at the beginning of every month. Yet, over time, you will likely become accustomed to spending within the limit of visible dollars in your account, post-savings. Whether early retirement, paying for your child’s college education, or buying a new house, the simple choice to initiate automatic savings will help make your goals a reality.
At Financial Synergies, we can help you set up automatic savings. Let us know the amount and how often you want the contribution to occur (monthly, bi-weekly, etc.). We can make contributions match the timing of your paycheck so that your dollars go to savings first. For those of you with inconsistent cash flow, please reach out to us to discuss how we can maximize the amount you save when you are paid. We exist to help you solve these problems.
Automatic savings free you from futile attempts at timing the market, eliminate unnecessary psychological stress, and place you on the path to achieving your goals. Every day spent waiting there is value lost. However, there is no time like the present. Grab your phone, give us a call, and turn on automatic savings.
Duhigg, Charles. The Power of Habit: Why We Do What We Do in Life and Business. Random House Trade Paperbacks, 2012.
Murray, Nick. “Introduction.” Behavioral Investment Counseling, The Nick Murray Company, Inc., 2008.
 Based on market close 10/06/2019
 In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero.
S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month US T- Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.