Simple Saving: The No-Budget Way to Spend Less and Save More

How are your New Year’s resolutions coming along? This is the time of year they start to slip—or even disappear! Maybe those great after-Christmas bargains were too hard to resist, so the resolution to save more money took a heavy hit in January. 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. As I indicated in my blog about a comment made by Meir Statman, we Americans are desperately in need of financial fitness. Despite our 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. By reducing spending by the drip, we don't feel the loss that often accompanies a noticeable budget restriction. 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?