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Tuesday, April 7, 2015

Making Momentum Work for Your Savings

Most of us have heard the advice to pay yourself first. Having your savings come off your pay before you see it is a painless way to save consistently. I have an idea to take this a step further to automate the saving of pay increases and bonuses.

Consider the example of a single 30-year old, Jen, who earns $65,000 per year. Every two weeks, Jen’s take-home pay is $1830 until October when CPP and EI contributions end, and then she takes home $2000. She hasn’t been saving any money and wants to start.

Jen could get her employer to split her paycheque so that a fixed percentage of her take-home pay goes to savings. Another possibility would be for Jen to have $1700 directed to her chequing account, and the balance directed to savings. This has the advantage that her spending is constant all year and the savings level changes when CPP and EI deductions end for her in October.

Another effect of this approach is that her raise next year will get diverted entirely into savings; she won’t see any difference in her level of spending money. In addition, any bonuses added to her regular paycheque will go entirely to savings.

Eventually, inflation will erode the value of Jen’s biweekly $1700 for spending, and she can go back to her employer to have this amount increased. But this is something she will have to take action to do. By default, raises turn into more savings; momentum becomes Jen’s friend.

There are people who won’t be able to use this idea. Highly variable income is a problem, and some savings plans may not be set up to take variable amounts in this way. But for those who can automate their savings with this idea, momentum becomes a driver for increased savings.

6 comments:

  1. I had a friend who did something similar, but saved the extra money so he could repair his sports car, so not the best way to use the extra money, but it worked for him.

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    1. @Big Cajun Man: As long as you have long-term savings in addition to short-term savings, your friend's strategy sounds fine, but I'm guessing there were no long-term savings in his case.

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  2. Or easier for most people, put pay into a savings account and automate a transfer to a chequing/spending account. It's just another automated transfer in your collection. Why bother with a payroll transaction? Seems like Jen is making extra work for herself with the payroll group on top of her planned visit to the bank to set up automated transfers anyway.

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    1. @Anonymous: "Savings" doesn't necessarily mean a savings account. It could be a TFSA or RRSP, in which case putting money in and taking back out is a problem.

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  3. This happens to my wife each fall, and I use it as an opportunity to do my contributions to my RRSP at that time as she has a strong government pension. It flattens out our income.

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    1. @Anonymous: It sounds like you found your own way to achieve something similar to what I was trying to automate.

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