How do I know if I’m Ready to Invest

- Saving

The fastest way to find the right answers is to ask the right questions—or at least ask enough of them. Good questions are homing devices for finding solutions and answers. Asking, “Am I ready to invest in the market?” is an intelligent question indeed. As you’ll see, it pays—literally—to look before you leap!

If your goal is financial freedom, you’re more likely to succeed at investing by being prepared. See if the following four statements fit your situation.

My Emergency Fund is in Place.

Do you have an emergency fund? You need some liquidity so the unexpected doesn’t create a financial crisis. Ideally, this means three to six months of expenses in savings. Investing is counterproductive if all your cash reserves are tied up in the market, an emergency arises and you’re forced into debt or bad decision-making.

If you haven’t met this goal yet, every extra dollar should go toward your emergency fund before investing. If you’re investing already, pause until you build up your emergency fund.

I’ve Addressed Any Debt Issues.

Interest accrued due to debt can surpass potential interest earned from investing. By paying down debt, you’re actually making money. For example, someone paying 15 to 20% interest each month on a credit card gets a return of 15 to 20% compounded by paying more than the required balance each month!

There’s no stock investment guaranteed to yield 20% compounded. Debt reduction on a credit card is a great deal—so pay down that debt and congratulate yourself. You’ve just gotten 20% on each dollar.

I Won’t Need the Money for More Than Five Years.

Investment values go up and down with market fluctuations. When will you need the money you plan to invest? The market might happen to be down at that time. Historically, there have been times when the market is down over a five-year period, but they’ve been less dramatic and less frequent than over a one-year period. Any goal that’s five years away or less is not something you should invest for. Put it in savings instead.

Let’s take this concept further. Can you lose any of the money at all? For example, you’re investing to save for a down payment on a house. You think a downturn is unlikely within eight years. What a bummer if you go to buy that house and don’t have enough because the market fluctuated! The more certainty you need with your money, the less likely you should be investing it. Risk decreases when your timeframe increases, so investing is a reasonable risk when you have a long timeframe.

I Can Tolerate Some Risk.

This one’s more of a gut check: If you’re a person who’s uncomfortable with any level of risk, investing might not be for you. What if the value of your investments goes down a little? What if it drops a lot and stays down a long time? These possibilities should not be so disturbing that they terrify you.

I always advocate peace of mind. My blog How to Make Money: Save It explains why your most important goal is saving. It’s planting the seed. Investing is just extra fertilizer to help your savings grow. The fertilizer is optional, so you can always put your money into something very, very safe and avoid losing sleep over it. Your portfolio should reflect your risk tolerance, which usually changes with time and life events. If you’re not comfortable with investing now, some day you might be ready.

Getting Your Financial House in Order

Yes, investing is important, but it’s even more important to get your house in order first. Once you’re ready to start investing, should you do it yourself? That will be the topic of another blog…

Buying Happiness: Anticipation Enhances Reality

- Spending

I was in junior high. It was 1984, the album was 1984, and the band was Van Halen. “Jump,” the only Van Halen song ever to hit #1 on the charts, began with a dramatic synthesizer solo that became the band’s signature sound. At that time I knew one thing: I had to have a synthesizer.

I was so captivated by the then-new, techno synthesizer sounds that I even agreed to take piano lessons. My parents said if I’d stick with piano, they’d split the cost of a less-expensive electronic Casio® keyboard with me. It wasn’t a real synthesizer, but I wanted that keyboard more than anything. I daydreamed about it, studied its specifications, made detailed drawings and talked about it incessantly. Looking forward to my keyboard kept me going for months.

Making Me Wait

Anticipation is a great bargain, because envisioning future purchases can produce a very positive emotional response. When it comes to money and happiness, imagination is a powerful capability of the human brain that lets us experience happiness even before we spend a dime.

Sometimes anticipation is better than the actual purchase. Studies show that looking forward to a happy event can produce more pleasure than the experience itself because fantasy is not intruded upon by reality. In the case of my keyboard, the reality of the plastic keys was disappointing compared to the weight of the ivory piano keys I’d envisioned.

Even when reality meets or exceeds our expectation, anticipation is a deal sweetener. We get pleasure from the actual item or experience plus the extra happiness of anticipation beforehand. Interestingly, several studies have suggested that positive feelings from anticipating a future event are stronger than those from recalling a pleasant event in the past. In other words, people seem to prefer a happy future more than a happy past.

Getting Extra Happiness Free

Here’s how you can buy a bigger slice of happiness using your very human feelings of anticipation:

  • Avoid “consume now, pay later”: You get a better deal on happiness by saving for a purchase than from the immediate gratification of charging it on the spur of the moment. “No interest, no money down” offers may be stealing some of your happiness! When you wait and save, you eliminate the possibility of regretting the interest applied to a credit card later and increase your happiness up front. You might start practicing with small pleasures because it takes less time to save for them.
  • Give yourself time to anticipate: To get more from an expenditure, let yourself eagerly look forward to what you buy. Take extra time thinking about it, and enjoy reminiscing afterward.
  • Use anticipation as free happiness insurance: Anticipation makes a purchase worthwhile even if the reality is disappointing. You can savor the idea of a Mexico vacation even if your luggage gets lost and the water doesn’t agree with your stomach. Without anticipation, you just have a bad memory of a bad vacation.

The No-Budget Way to Spend Less and Save More

- (No) Budgets , Saving , Spending

You thought simple saving was within reach. You’ll do better this month, right?

Obviously we need a consistent, predictable way to decrease spending and increase saving. Despite this dilemma, we balk at the thought of completing a budget.

Why Budgets Don’t Work

Budgets are the traditional way of managing spending and saving habits. Yet psychologically and behaviorally speaking, budgets—like diets—don’t really work for most people. The New
York Times article Why a Budget Is Like a Diet—Ineffective tells us that human nature can foil the best of intentions!

Some people do well at budgeting. With couples, sometimes one person is more conscientious about money management and adhering to a spending plan. If you’re a good budgeter, keep it up, because it’s an effective tool. For the non-budgeting majority, there is hope! We can comfortably reduce spending and increase savings using the two-bucket spending method with a drip-by- drip savings plan.

The Two-Bucket Method

Behavioral economics research tells us we tend to separate in our minds various purposes we have for our money. This “mental accounting” can be to our advantage. If we have a purpose for a certain amount of money, we tend to avoid using it for other things.

The two-bucket method I describe here helps you start putting mental accounting to work on
paper! It’s simple:

1. Set up two bank accounts, preferably at the same bank. Ideally, one should be a checking account and the other a savings or money-market account. These are your two “buckets.”
2. Label the checking account your “Spend” account and the savings your “Save” account.
3. Link the two accounts so you can transfer money between them easily. Banks that allow you to set up automatic transfer via the Web (most do) are more convenient too.
4. Pay yourself first! Instead of depositing income into Spend, put it all into Save. If you have automatic deposits, direct them straight to savings.

Income goes directly into Save, so simple saving is your default option. Because the default requires no effort, you’re taking advantage of a behavioral economics technique called
automaticity. You are saving automatically and have achieved a big milestone for simple saving. Congratulations!

Saving Drip-by-Drip

Your mental accounting is probably already in gear. Here’s how to build your savings and imperceptibly nudge yourself to wealth:

1. Time an automatic transfer after each payday to move money from Save to Spend. The transfer amount should initially be 99% of your paycheck. If you are already saving, bravo! Set the transfer to preserve your current saving rate.
2. Always pay bills and take spending money from the Spend account. Keep track of your balance and don’t overspend it.
3. Each month, decrease your automatic funds transfer by 1% of your income. For example, if you started with 99%, transfer 98% from Save to Spend the second month, 97% the third month and so on. Each 1% is just $10 per $1000 in monthly income. If you’re paid $4000 per month, you’ll only be reducing spending by $40 per month. Painless!

Our brains are wired to notice sudden or dramatic changes, but not small changes over time.  We find small ways to trim. It’s possible to reach a savings of 20% or more of income without suffering from the pinch. Bill payments and basic “creature comforts” are a must, so when things get too tight, that’s the signal to stop increasing the percentage.

Time for a Reward—and a Fatter Retirement Account

Phew—no budget! Once you have money accumulating in savings, reward yourself. One way is to take up to 50% of what you accumulated in the Save account after six months and do something special or fun, like a nice massage or a dinner out. What about the rest of the savings? Well… remember your New Year’s resolution to put more in your retirement account?

Simple Saving: Organizing Your Accounts

- Saving , Uncategorized

My financial spring cleaning happens early in the year as I prepare to file taxes. I usually go through my folder containing various documents I’ve accumulated for tax time. If you’re like me, you’re not perfectly organized either. In fact, after reading about the various accounts you need for financial fitness, you might think, “You talk about all these different accounts… What’s the simplest version I can assemble of that?” Today’s blog brings everything together so you can keep your financials in order.

Now is the time to organize and simplify. Why be bogged down in old paperwork and dormant accounts? You might have accounts you opened for a special purpose and forgot about or accounts you used before moving to a different city. You could have old 401(k) accounts from previous employers and investment accounts with various brokers. Let’s look at the easiest way to get organized!

Two Types of Accounts

You can categorize your accounts as either cash-flow accounts or saving and investing accounts. Cash-flow accounts are needed either for frequent access or as a 911 emergency fund. Saving and investing accounts involve money you won’t be touching for a long period of time.

Your needs are different with each type of account. When opening cash-flow accounts, look for convenience and low fees. Because the money isn’t parked for a long time, interest rates aren’t top priority. You can try squeezing out that extra .5% interest, but it’s not worth sacrificing convenience. A local bank or credit union where you can go in person is ideal, and online access helps.

Saving and investing accounts are different. You need good investment options—including index mutual funds and ETFs—and minimal expenses. Service is more important than convenience, because you don’t need a local branch. Look for high returns combined with low fees. Every percentage point of interest is significant.

Cash-Flow Accounts

Here’s a list of cash-flow accounts that help you reach and maintain financial fitness. Though credit card accounts represent cash flow, they’ll be covered in a later blog, and you only need one—or none!

  • Spending account: You use this checking account to pay bills and expenses each month.
  • Income account: This is a savings account where you deposit your paychecks. Automatically transfer your monthly “allowance” to your spending account as I’ve described in my uneven cash-flow blog.
  • Purpose-goal account: Use a savings account for accumulating money toward your short-term purpose goal.
  • A 911 Fund account: This is your emergency fund containing three to six months of expenses. Use an FDIC-insured savings account with a good interest rate, and remember quick access is of primary importance.

Saving and Investing Accounts

If possible, choose a single investment company for the saving and investing accounts listed here. The exception is a 401(k) or 403(b) account, because your employer picks the custodian.

  • A 401(k) or 403(b) account: This should be your current employer’s retirement plan. Contribute enough to get the employer match if one is offered.
  • Roth IRA: If you qualify, this is usually your first choice for easy investing for financial freedom. That’s after getting any 401(k) employer match.
  • IRA rollover account: If you have a 401(k) with a previous employer, roll it over immediately. You only need one IRA rollover account for all plans you’re rolling over.
  • Educational investment account: If you’re saving for your child’s college education, open a 529 education account. You only need one regardless of the number of children you have, and it’s a great place for cash gifts from the grandparents.
  • Other investments: To save for additional long-term goals, you may need a regular investment account, sometimes called a brokerage account. You need just one of these. If your goal is less than five years away, save the money instead of investing it.

Simple but Practical Financials

My simple saving blog helps you decide where to put your money first. It would be nice to simplify everything to the point of having only one or two accounts. However, to take advantage of tax savings and the mental accounting that comes with separating money according to its purpose, you’re best off with categories like I’ve outlined here. This strategy balances simplicity with sensibility.

 

What Are You Thankful For?

- (No) Budgets , Spending

“Daddy, what are you thankful for?” my five-year-old asked. We were at the breakfast table with my youngest, age two, after a hectic frenzy getting ready for school. This direct, innocent question was probably prompted by school discussions.

Surprised but inwardly pleased, I smiled and said, “Well, of course I’m thankful for you!” Then I smiled at my other daughter and explained how I was thankful for her too, as well as for my friends.

After I said, “I’m thankful this house,” my five-year-old piped up, “Yeah, because some people are homeless.” I agreed. “And some people are poor,” she said, “and we’re not poor.”

There are many reasons to count your blessings. It’s good for your soul and your mental well being. It’s also good for your personal finances due to something called social comparison.

Make the Right Comparisons

It’s human nature to make social comparisons, comparing ourselves with those around us. In particular, we tend to compare our wealth with others’, both consciously and unconsciously. The negative side is “keeping up with the Joneses”: They accumulate more and more possessions, so we think we need to match their pace. What a source of discontentment that can be!

There’s a flip side. A tried-and-true advantage of pausing to count your blessings is remembering how very fortunate you are. No matter what your plight or your station in the pecking order of socioeconomics, you’re probably better off than somebody else.

For example, are you reading this on a computer?

  • Likely you’re not homeless—and many people are.
  • You’ve probably eaten something today—and there are those who can’t even get clean water.
  • You have the means to access and use a computer, which many people don’t have.
  • You have time to read, while some are too busy.
  • You can read—and illiteracy, even in the United States, is quite high.

Thankfulness involves a conscious choice about our social comparison point. We can compare upward or downward. Always comparing ourselves to folks who are more materially wealthy than we are gives us the consistent feeling of a “have-not.” However, if we compare ourselves to those who have less and take a moment to be grateful for what we’ve got, we feel wealthy and blessed.

Giving also multiplies our sense of wealth. As I mentioned in my blog Spending on Others is Buying Happiness for Yourself, giving just $5 a day can boost your mood and positively affect your outlook.

See the Big Picture

We compare upward too often when we’re always exposed to people who have more. Watching newscasts or documentaries about less fortunate individuals brings reality into focus. We get a more balanced comparison and can truly see the heart-wrenching conditions numerous people face on a constant basis.

In high school I dated a woman whose parents had spent years as missionaries in Africa. Her father, Jack, was a minister. He’d eat only a small bowl of rice for lunch on a daily basis—and nothing else. For decades this was his way of reminding himself that most of the world lives off the same amount of food or less each day. Jack turned lunch into a thankful moment as part of his routine. He didn’t want to lose touch with how blessed and fortunate he growing up in this country where we have so much.

My blog With Buying Happiness: It’s the Little Things talks about fostering a sense of gratitude and avoiding taking things for granted. Yet another way to bring thankfulness into perspective is to compare your current wealth or possessions with having nothing. Maybe you need (or want) the latest iPhone®. What about having no phone at all?

Look Beyond the Trappings
Obviously, July 4th is more than just Fireworks and Thanksgiving is more than just turkey. A grateful outlook improves our satisfaction levels with life and with our possessions.

Maybe we should all be like Jack and have something in our day prompting us to pause and remind ourselves of how fortunate we are. So take a moment. Count your blessings and realize just how wealthy you really are. Regardless of what you have, you always feel richer when you’re grateful for it!

How to Make Money: Save It

- Retirement , Saving , Uncategorized

There’s plenty of advice out there about how to make money in the financial markets. Many people think investing is the key to wealth-building, and investment strategies abound. There are also people who, strategy or no strategy, dream about picking that magic stock that will put them on Easy Street. Sure, investing’s important—but if you really want to know how to make money, you’ve got to go back to square one: saving.

Something as mundane as saving doesn’t get much press. However, you’ll make more money by saving it than by intently focusing on earning from the gyrations of the market. Even a better-paying job won’t help if you don’t know how to make money the boring way. If your saving habits remain the same and you’re spending the rest, the net effect of a pay increase is zero.

Go for the Greatest Money-Making Impact

The leading and most important factor for wealth building is saving.

Obviously, even a phenomenal investment strategy is useless without money. Although saving ranks number one for how to make money, few have learned to be savers! Not even Warren Buffett could invest what the average American household has saved and turn it into an adequate retirement nest egg. You must contribute to your nest egg by saving, because the market will not do it for you. To earn a dollar in interest, you need to save twenty of those dollars first –  that’s assuming a 5% rate of return!

Learn how to Make Money Using the Gardening Concept

 Your earning ability is like the garden plot where you can plant. The more you earn and the more years you’re working, the bigger your plot is. That gives you more potential for wealth. Saving is planting the seeds. However, even a huge garden plot (large income) won’t yield a decent crop if you don’t plant (save) much. Investing is the crop diversity and fertilizer. Being smart about fertilizing can add to the yield of your crop, but it doesn’t replace having a plot or sowing seeds.

Those with great big plots who don’t plant many seeds won’t have much to show for it. People who have tiny gardens but plant and fertilize diligently can eat well and have quite a bounty!

Put Saving Strategies Before Investing Strategies

Lots of people get tied up in knots trying to figure out how to make money through investing. Don’t fall prey to this confusion! The gardening concept described above is the best perspective you can have. For most of your earning years, how much and how consistently you save has more impact on your long-term wealth than the return you get on your investments.

Improving your rate of return only has a significant impact after you’ve accumulated a large investment portfolio. Getting 1% more in interest on a $1 million portfolio is significant. Struggling to eke out a 1% interest increase on $10k portfolio won’t make much difference. What’s really powerful is saving and adding to the plants in your garden so there’s more for that higher interest rate—the fertilizer—to work on. While you’re saving, don’t forget to examine your finances as a whole to be sure you’re ready for the investing step.

Spending on Others is Buying Happiness for Yourself

- Spending , Uncategorized

When I was younger, I had a regular Sunday evening volunteer gig helping prepare and serve meals for homeless teens at a local shelter. At first, I did it because it was the right thing to do. Soon I started looking forward to these evenings because helping the teens made me feel good. They were so appreciative, and it was obvious I made a positive difference in their difficult lives. Needless to say, the only cost was gas money to get to the shelter!

Just about everyone knows the good feeling that comes from helping others. Our brains are wired for social connections, so almost anything that strengthens these connections—including the way we spend money—seems to increase our happiness. There’s more to financial fitness than numbers, and the positive feelings we get from using money this way are very real.

Part Of How We’re Wired

Animals can’t create social networks more complex than ours, and only a few come close. In fact, ours is the only network that includes perfect strangers. Scientists believe the positive feeling from helping others is rooted the hyper-social nature of humans. We’re hard-wired to connect.

We might object to the scientists’ beliefs by saying those good feelings come from cultural influences or a person’s upbringing. This isn’t the case, because the effects of spending on others (prosocial spending) have been demonstrated from Canada to East Africa, making it a cross-cultural norm.

More Evidence for Getting From Giving

Many people involved in philanthropy and volunteerism say they get more back than they give, and evidence backs this up. A number of scientific experiments have demonstrated that prosocial spending tends to increase happiness.

One study using MRI scans showed that the brains of participants who were thinking of donating money to charity became active in brain areas usually associated with getting a reward. Amazingly enough, when we give, we feel like we got rewarded. Our brains act like we’re on the receiving end. It’s how we experience giving physiologically in our brains that connects money and meaning in this way.

The Expectation of Happiness

Imagine I just handed you a $100 bill outside the shopping mall. Do you think you’d get more satisfaction out of buying something nice for yourself or by dropping the money in the charity pot of the Salvation Army® Santa ringing a bell outside?

While most of us have experienced the good feeling that comes with giving, we seem to discount it when deciding whether to spend money on ourselves as opposed to someone else. We expect that we will feel happier after spending on ourselves than we will after spending the same amount on others. Interestingly, the opposite is usually true.

When we expect to feel differently than we actually do when an event occurs, we make what psychologists call an “affective forecasting error.” You might be unsure if you make affective forecasting errors when it comes to giving—unless, that is, you test the concept yourself.

Easy Experiment to Try

Research suggests that giving away as little as $5 a day results in a significant boost to your mood—but don’t just take my word for it. Try it yourself for a week as a fun-finance activity. Make it your goal to spend $5 daily for seven consecutive days on little treats or gifts for others. They could be family, friends, acquaintances or even strangers. The following week, buy a $35 treat for yourself—just a small pleasure—as a reward for your generosity.

I’d love to hear the results of your experiment. How did you spend the money on others, and how did you spend it on yourself? How did you feel each week? Be sure to post a blog comment and let me know!

What is Financial Freedom Anyway

- Retirement , Saving , Uncategorized

It’s interesting how elusive something can be if you don’t have a good definition for it. For instance, lots of people want financial freedom, but what exactly is it? Some see it as a vague goal or distant dream. Others think financial freedom is only for an elite few. Financial freedom is a great concept, but can you define it and determine where you stand with respect to being financially free?

How Most People Think About Financial Freedom

Before I give you my take on this, let’s explore what most people think:

  • Financial freedom is being out of debt: Often people make financial freedom synonymous with freedom from the shackles of debt. I agree this is important, because until you dig yourself out, you’re certainly not free. Consumer debt—that relentless revolving credit—is extremely restrictive. It seems more painful than a secured debt like a mortgage, but today secured debt can be insecure. Recently we’ve seen how a mortgage can impinge on freedom. A house that’s under water isn’t truly a secured debt anymore!
  • Financial freedom is having just enough to meet my needs and fund my retirement: Some think a person is financially free if there’s enough money coming in from passive sources, now or in the future. The word “passive” in this case refers to income for which there’s no need to work. Investments, social security and pensions are some examples. By being careful, a person in this category can afford a traditional retirement at around age 65.
  • Financial freedom is having enough for my needs, most of my wants and a very comfortable retirement: Some people think financial freedom belongs to the independently wealthy, those who can do whatever they want without spending time working. These individuals might have had a windfall and used it wisely. It could also be that their careers, investments and money management techniques made them very prosperous. The end result is an extremely comfortable retirement and many wants being met over the years.
  • Financial freedom is being able to purchase anything and everything I want: Certain people think financial freedom applies only to the small category of extremely rich people like Warren Buffett and Bill Gates. There is nothing purchasable they cannot buy.

Financial Freedom as a Continuum

Those are reasonable ways to describe financial freedom. However, here’s why I think they miss the mark: They’re all-or-nothing definitions where you’re either free or you’re not. Financial freedom isn’t about whether or not you’re free. It’s about degrees of freedom.

At Money Mentals we don’t say, “At this point, you’re financially free.” Instead, we talk about incremental freedom. We call it Months of Freedom, which how many months you can go without having to earn an income.

Freedom to Celebrate

My blog Seeking Financial Freedom, not Just Retirement talks about how retirement is being redefined today. We need to redefine financial freedom as well, because the all-or-nothing approach is inaccurate and too restrictive. It can even be a real downer! Many people can’t feel like they’re free until they’ve achieved tremendous riches—so why start? For some, just digging out of debt is a long road.

If you think of freedom as incremental, buying another unit of freedom is within reach. Tracking your Months of Freedom gives you a lot of freedom in itself, because each little bit saved brings you closer to another month gained. Your time takes on a whole new meaning. The discipline and sacrifice involved in work become more worthwhile.

Financial freedom doesn’t have to come all at once at the end of your life. For example, someone with a small amount of freedom might choose to take a sabbatical or work part time.

Most of us never get to the Warren Buffett and Bill Gates version of financial freedom. Many may never even get to the comfortably retired version. That doesn’t mean we have no freedom at all! Let’s reframe our thinking so we can celebrate our progress and keep on becoming increasingly financially free.

How To Manage Your Money When Your Cash Flow Is Uneven

- (No) Budgets

We need predictability in our lives, because too many changes and surprises can be unsettling. Irregular income and out-of-the-ordinary expenses are two financial factors that can throw us off kilter—unless, that is, we learn how to manage the unpredictable rollercoaster of uneven cash flow.

Many people get steady paychecks for approximately the same amount every two weeks. On the expense side, bills are usually monthly, involving routine things like mortgages and car payments. Managing money isn’t difficult when everything occurs consistently on a monthly basis. If inflows and outflows don’t match up, things get complicated.

Assessing Inflows and Outflows

Uneven cash flow can be related to inflow, outflow or both. Many people have irregular income due to their jobs or other factors. They might be small-business owners, seasonal workers, freelancers, people who count on commissions or bonuses—or even those supplemented by Grandma’s occasional gift checks.

Expenses are different. We all have uneven outflows some time during the year, because not all bills arrive on a monthly basis for manageable amounts. For example, insurance can be paid monthly, quarterly, every six months or annually, depending on the type of insurance and carrier.

Managing Irregular Income

Often those with irregular income must pay bills today when money will come in next week. Businesses handle this using either a line of credit or a cash reserve. Individuals, however, can get into debt problems without the right strategy.

The goal is to make irregular income regular so money is available for expenses regardless of when expected inflow arrives. Like businesses, individuals can accomplish this using either credit or a paycheck account—and the latter is definitely the better option.

  • Credit: Using a credit card or line of credit and paying it off when money arrives is risky. It’s tempting to rationalize splurges by thinking you’ll pay it off later. Credit is fast and convenient, and you don’t have to keep a lot of cash in the bank, but I don’t recommend this deceptive road to debt. The consequences are much greater for you than for a business.
  • Paycheck account: Open a savings account that’s your “paycheck account” and always deposit your income there. Pay yourself a regular paycheck biweekly or every month by transferring a set amount to your checking. Savings account interest rates are low now, but you’ll eliminate any potential for incurring credit-card interest payments. This gives you an instant raise!

Start building your paycheck account when a larger inflow comes in, such as a check for completing a major project. Be disciplined about increasing that reserve over time so you can begin paying yourself regularly.

Managing Irregular Expenses

You might be doing very well using my no-budget system when suddenly a very large bill appears that your income can’t cover. The options and techniques for managing irregular expenses are similar to those for irregular income:

  • Credit: You can pay irregular expenses with credit. This is bad news for all the reasons mentioned earlier.
  • Cash reserve account: The ideal solution is opening another savings account that’s your cash reserve and making periodic small deposits toward larger expenses. Your cash reserve account helps you turn large irregular expenses into predictable monthly ones. For example, your auto insurance policy is $600 annually. You can pay $55 each month, but yearly is cheaper because it’s the equivalent of $50 per month. Therefore, you deposit $50 into your cash reserve account every month. When the $600 auto insurance bill comes, your payment is ready. You’ve skipped the $5 monthly finance charge while earning a little interest to boot.

A single savings account can serve as a cash reserve for multiple irregular expenses, including life insurance, disability insurance, estimated taxes, heating oil and so on. You can track sub-funds in your reserve account, but this is optional.
A cash reserve account is for anticipated future expenses. It’s an entirely different account than your emergency savings (911 fund), which is for unforeseen irregular expenses such as a job loss or major car repairs.

Creating Predictability

To keep inflow separate from outflow, maintain a separate paycheck account (if needed) and cash reserve account. That way you won’t be tempted to combine them and take a “bonus” when you see extra money that’s temporarily in your reserve account. Two accounts might mean a little more effort, but they’ll give you the benefit of mental accounting and keep you honest.

The pain of credit card debt is so excruciating that it makes the low interest offered on savings accounts a pleasant option. Enjoy mastering uneven cash flow with your paycheck account and a cash reserve. The sense of control is worth it!

Mind Your Money: Optimism & Illusion of Control

- Spending

Humans are an optimistic breed. We believe we can defy the odds and control our own destinies. When we’re told that about half of all marriages end in divorce, we’re still convinced we’ll live happily ever after. When we’re told that 80% of new businesses fail, we’re confident our startup will be the one in five that survives. When we’re told we’re more likely to be struck by lightning than win the lottery, we say, “Well, somebody has to win!”

It’s as if we’re born with rose-colored glasses pasted to our retinas. Though we usually don’t recognize it, we carry with us a persistent optimism and an illusion of being in control, and these can lead to faulty financial decisions.

Optimism and Overconfidence

Most people have a positive view of their abilities and prospects of success. This personal bias toward optimism and overconfidence is a fundamental finding in behavioral economics. Here’s a classic example: If people are asked to rate their driving ability, 75% to 80% think they’re above average. The same goes for almost any other domain: sense of humor, entrepreneurship, success in marriage, profession, grades and so on. Depending on the study, 75% to 95% give themselves above-average ratings, although by definition half should be above average and half below.

Such overconfidence is DNA-coded. If we weren’t so optimistic, we probably wouldn’t be motivated to do much of what we do—to try different options, innovate, make changes for
the better—because we wouldn’t have hope. We need optimism to push past inertia, even when it comes to raising kids or getting out of bed in the morning.

Illusion of Control

In addition overconfidence, we tend to have an almost irrational sense of how much control we have over circumstances. We actually think we can influence outcomes when we have no control! For instance, people are willing to pay four times as much for a lottery ticket so they can pick the numbers, even though winning numbers are selected absolutely at random. Do we actually believe that picking numbers ourselves makes us more likely to win?

Early success strengthens the illusion. For example, one study showed that people who correctly guessed the outcome of several early coin tosses rated themselves as much better guessers than those who’d started badly. Illusions of control also increase when you have many choices, the task is familiar, there’s a lot of information and/or you’re personally involved.

Resulting Money-Management Decision Errors

Our optimism and false sense of control are not necessarily bad. However, here are ways they can keep us from making good financial choices:

Interpreting lucky investing decisions as skill: Illusions of control can flourish in an investing environment. Sometimes we make a lucky guess and then believe we controlled the
outcome, only to find that the next outcome is disastrous because we never had control in the first place.

Banking on successes in real estate: During a real estate boom, a friend of mine purchased a condo that quickly doubled in value. He tried to repeat his success just in time for real estate to crash. Thinking we’re in control due to an early success, an abundance of information and personal involvement with a familiar task can lead to bad places.

Having a low or nonexistent emergency fund: Feelings of optimism and control can make us think life will always treat us well. For example, if we think we’re so proficient at our job
that we won’t get laid off or our car was such a perfect choice that it won’t break down, we
might underprepare for a layoff or car trouble. It’s dangerous to skimp on a 911 fund.

Underestimating the need for insurance and estate planning: Thinking, “It won’t happen to me,” when it comes to severe health problems, disability or an untimely death can lead
people to remain uninsured or underinsured. Many put off creating a will and pass a lot of stress to their loved ones after they’re gone.

Hope is essential for a happy life. Depression research shows that depressed individuals aren’t necessarily irrationally down, they’re just not as irrationally optimistic as the rest of us Perhaps the best antidote to the error of overconfidence is following the old adage to hope for the best, but prepare for the worst—with a bit more emphasis on preparing!