Why Don’t We?

This is a guest post by Robert, who lives in Calgary and works as a financial adviser. He is married, has three kids and plans to retire at age 35.  Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.

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 feels 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 we risk feeling jealous. We easily rationalize that if they can spend so “carelessly”, so can we.

In order to succeed, we need to counter these natural tendencies. The first step is to create a plan that really works. 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 some 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, realize 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. 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.

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, saving 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 good examples and making those actions as automatic as possible helps to avoid the discomfort that otherwise might be experienced.

Do you have automatic savings? Other than this blog, where do you find good examples of wise financial choices? How else do you get things done when you know it’s important, but it feels uncomfortable?

5 thoughts on “Why Don’t We?”

  1. I think people understand financial basics but don’t actually practice what they know or preach because we have to live and learn. We splurge on the sports car, and we’re thrilled with the attention and compliments, and it’s not until we feel trapped by the high payments that we resolve to pay off what we owe and never be in that situation again. It’s almost like you have to experience debt or get a taste of it to really “get” that it’s something to be avoided, and by the time you learn that lesson, it’s a lot harder to get back on track financially.

  2. “… if I save $800 per month for eighteen years, I will have around $800,000.”

    Is this accurate, or just hypothetical? How are you getting $800,000?

  3. Trev, the $800,000 is hypothetical. At 8% growth over 18 years with no additional deposits, it would mean starting with $500,000. On the other hand, starting from $0, it would mean saving $1,667 per month. It was meant to be an example of a financial plan.

    Personally, I’m not counting on pension income because I want to retire before 65. I also plan to work outside the country, which means not qualifying for CPP or OAS. Still, I could live on $40,000 per year.

  4. The other questionable assumption with this:

    “I will have around $800,000. That should provide $40,000 per year after-tax income”

    …is that to reach 40K in after-tax income, the portfolio needs to generate about 50K annually…that’s a 6% return.

    That may be possible, but if you don’t want to risk running out of money halfway through retirement, a 4% withdrawal rate (indexed to inflation) is a safer approach.

    That missing 2% dramatically reduces the after-tax income from 40K to about 27K.

  5. Erik, you’ve obviously put some thought into this. I’m glad that the idea was thought provoking.

    When you say “questionable assumption”, you’re judging my hypothetical plan. I’m not sure why. I read an academic paper by Moshe Milevsky about whether or not 4% is a sustainable withdrawal rate. I think the assumptions are that the stock market produces returns that fit a normal distribution of returns (which it doesn’t) or that history repeats itself (which it doesn’t). Either way, using 4% is safer, but using 3% is safer than that and 2% is even safer. Personally, I plan to use a 0% withdrawal rate for as long as possible, working enough to cover my needs.

    There is no absolute safety in life.

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