Updated: Sep 17, 2018
Written By: Mr. Horizon
Anyone who has ever picked up a book, talked to a guru, or searched the web for personal finance will have undoubtedly heard of the phrase “make it automatic.” I was introduced to this over a decade ago when I was (like many) stuck in an airport on a long layover. I was perusing the stores that line the airport filled with over priced goods and I decided to picked up my first financial book I ever read, The Automatic Millionaire, by David Bach. Interestingly enough, I overpaid and purchased this book in the airport (I don’t suggest this, try your local library). This book was packed with information and was the spark that ignited my interest in becoming the master of my own personal finance. This resulted in reading many more books, blogs, articles, and eventually leading to the financial independence journey Mrs. Horizon and I are currently on. The book is not very long and only containing eight chapters but one key theme permeates throughout “AUTOMATE EVERYTHING.” Mrs. Horizon and I have found some unbelievable advantages to automation and I wanted to share our findings with everyone. Please take a minute and read through the different reasons we find automation to be so powerful. If you find any of the nuggets valuable pick them up and add them to your toolkit along your own financial journey.
1. Choices Are Exhausting
Studies have shown humans have a limited ability to make decisions. The ability to make decisions deteriorates the more decisions that have to be made. This is known as “decision fatigue.” This is why highly successful people such as Mark Zuckerberg and Steve Jobs wear the same outfit every day, and why Warren Buffet has only two selections for breakfast every morning from McDonalds. If each time you got paid you had to sit down and make a conscious decision to save, chances are, at least a few times, you would choose not to. I would argue that it would be closer to 50% of the time, but I have no study to show that, only personal experience and observation. What about paying that extra principal payment on your mortgage each year to cut down on the interest like you know you should? If you did not have to choose to do that it would make it so much easier. What if I told you if you made it automatic not only would you not have to be exhausted by the decision, but you also would not even realize it was gone?
2. You Don’t Miss What You Never Had
Have you ever wondered how no matter how much people make many have nothing left prior to their next paycheck? This is because psychologically when the money goes into one’s bank account they immediately lock into the amount they can spend. There is an easy way to change this so you never see the money hit your bank account. Have automatic deductions taken directly from your income sources the day your paycheck is received. If this is done correctly you never see the money and you cannot miss what you never had. On top of that you will be growing your nest egg for the future or saving that emergency fund we all need to have.
3. Why Give it to Uncle Sam?
Automating investments into 401Ks or IRAs can be incredibly powerful. Why give money to the government when you could give it to your future self? By using WHY #2 combined with a 401K or IRA you can truly realize the full potential of automated investing. Let’s just say you are in the 25% tax bracket that means for every $100 you earn, $75 is yours and the rest goes to the government (it is actually less than $75 when you include Medicare, FICA and State). 401Ks and IRAs allow you to save this money pretax and they grow tax deferred. Here is a quick example using a few easy numbers. If you had a household income of $50,000 per year and you are in the 25% tax bracket you would bring home $37,500 and pay the government the other $12,500. What if you maxed out an IRA or put money into a 401K? The max you can currently put into an IRA is $5500 so I will use that for this example. You save $5500 and it will grow tax deferred until the age of 59.5 when you can begin to withdrawal it. This drops your gross income to $44,500. In turn, you bring home $33,375 and the government would get $11,125. Essentially what this means is the immediate return on investment is $1375. The government is literally paying you to save money for your future self! Check out the financial independence calculator to see just how much that $5500 annually is worth to your future self. https://www.crossingtheeventhorizon.com/fi-compass.
4. Set It and Forget It (kinda)
This comes right out of the Mrs. Horizon play book. She does not want to have to worry about remembering to save each week. Automating savings and just doing monthly or even quarterly check-ins to make sure everything is aligned with your goals makes it so easy. We both choose many forms of automation, but she looks to hit the easy button as often as possible (she is a hands-off investor). It is her investment style and, in some places, it actually pays off way better than trying to do it yourself. It comes back to WHY #1 making choices is darn difficult and the less you can make to achieve your goals the better each one of them will be.
For most of us making these two things automatic will make the largest impact in reaching financial independence. For 401K participants think about what is the maximum amount you feel comfortable with and then go a few percentage points higher. At a minimum start by getting the company match if available. Then set up to have this percentage automatically increased every time you get a pay raise until you are maxing out your contributions. Try to get this set up before you ever receive the first paycheck. This prevents you from ever seeing what a paycheck would be without the deduction. For those without a 401K use an IRA and do the same if you cannot max it out right away start with $100 a paycheck and increase it by $20 each month. In 6 months, you can stop increasing because you are well on your way to maxing out your IRA for all following years. Don’t worry because you won’t miss it because if it is set up to be automatically withdrawn on the same day you receive your paycheck you will not notice.
Setting up automatic savings to your brokerage can be just as important when you are further down the road. If you are automatically maxing out your 401K and IRA you are likely looking for another place to save. Although this does not have the tax benefits of your other accounts you will be amazed at how automatically saving a set amount each pay check will grow. Start small some brokerages will let you deposit as little as $20 bi-weekly if it is set up automatically. Grow this automatic savings rate each time it feels like you have extra money. You will be amazed to see how fast it grows.
Mrs. Horizon and I do not do this one, but I will share it with you anyway because it is incredibly powerful. (We use an amortization tool we created in hopes to pay it off even faster and will upload to the FI Compass soon) Most people get a 30-year fixed mortgage and pay diligently every month. What if you could pay off this mortgage in a little over 20 years and save yourself thousands in the process by making it automatic? The key is to change to bi-weekly automatically withdrawn payments. This effectively pays one extra payment each year which will save you tens of thousands of dollars in interest over the course of the loan. By making it automatic and setting it up to come out as soon as you get paid you will not notice you will only see what is left.
4. Investment Rebalancing
This is very important to keep your risk allocation where you want it to be. We all develop a strategy when we decide to invest for our future. Typically, we set it up in the beginning to have certain percentages to different types of investments. This could be stock, bonds, real estate, and many others. Many do not evaluate this percentage after initially setting it up themselves or with their advisor. This is where automatic rebalancing comes in. By having an account set up to automatically rebalance periodically your account’s asset mix stays aligned with your risk tolerance. It has the advantage of automatically taking profits from highly performing investments and diversifying your portfolio to the asset mix you originally selected. Most importantly it prevents you from making emotional decisions about jumping in and out as the result of market conditions. With automatic rebalancing you can focus on the long-term horizon and ignore the day to day swings of individual investment options.
5. Credit Card Payment
Most of you are probably like “credit card payment?” Credit cards are great if you understand how to use them to your advantage. Most have incentives which pay you 1%, 2%, or 3% cash back or if you are into travel cards there is a slew of options here. The thing is you must understand that it must be paid in full every single month to reap this benefit. In my opinion credit card companies are loan sharks, but if you understand how to use them they can be a tool to save money not cause you to spiral into debt. All credit card companies will allow you to set up an automatic payment to pay your entire balance in full every single month. This means you never pay a penny in interest and get the discount and perks on every item you buy. This one needs to be used with caution, but as long as you have self-control and choose to automatically pay your card off in full every month this is another option out there where automatic is incredibly beneficial.
6. Bill Pay
This one is a bit tricky and I will give you my take on it. Automatic bill pay is fine if there is some incentive for doing so. For example, Sprint typically give you $10 off if you set up automatic and that is worth it to me. I would not do this for most of your day to day services though. It is important that you understand what you are paying for and review each bill to ensure there are no errors. Auto bill pay can make payments a little to casual. A place where this can happen is most people have internet, but don’t realize almost everyone is on some form of promotional rate that falls off at some date in the future. When it falls off you can typically call and almost instantly get on a new promotional rate. If you have automatic bill pay you may not notice causing you to overpay for services.
7. Health Saving Account
I, like many, have a high deductible savings account and an HSA. Mrs. Horizon and I anticipate reaching our deductible every year. To remove the immediate cost of any doctors visits I worked to get my deductible saved into my HSA. After I reached this amount I got an HSA debit card we use for visits. Then I took the deductible and divided it by 26 (number of paychecks). I now have that value automatically deducted from my payroll an put directly into my HSA. This way we always have a revolving balance equal to our deductible. You are not taxed on this money and we are going to use it for medical bills anyway. On top of that you can invest any money in HSA into sponsored investment vehicles and it grows tax free. That is correct, as long as you use the funds on medical expenses it is TAX FREE FOREVER!! Not tax deferred so it is even better than 401Ks or IRAs.
Mrs. Horizon and I use automation as a tool to help us reach financial independence. In this trekking guide we have covered the “why we automate” and given you examples of where we choose to automate. Automating our finances does not mean we ignore them. Automation helps take the decision-making process out of the equation. This allows us to focus on other important decisions with out suffering from decision fatigue. It prevents life inflation because we do not typically see large amounts of money in checking accounts as the result of all the automatic saving occurring in the background. It saves us a bunch of money in taxes and allows us to max out our tax deferred accounts decreasing the amount of time it will take us to reach financial independence. Lastly, it allows us to put our savings on ‘cruise control’ and reach our goals. This is great for when life gets crazy or if you just go on a trip and don’t want to have to remember to put that $100 in your brokerage or IRA. I hope everyone that reads this can apply at least one of these to your life. Remember we are all on this journey together and we are just sharing our story so HYOY!!