For most people, money management is one of the most painful parts of adulthood.
It is right up there with taxes and wisdom tooth extraction.
If you’re like me, you’re constantly guilty about spending money. That coffee. Those shoes. That not-the-cheapest Uber I took once. But then I ask myself, if you can’t enjoy spending money, what is the point of earning it?
Another common problem is the “end of month crunch”. You get your salary at the beginning of the month, and you feel rich. Life is wonderful. But by the end of the month, you’re reduced to Maggi dinners and movie nights at home.
Still, others don’t worry about money until the “big unexpected event”. Your phone falls into a puddle. Your friends plan a trip to Ladakh. Horrors! You will have to ask your parents for help. And isn’t that always fun?1
The problem with trying to spend less is that it is painful and ineffective.
Our parents’ approach to saving was simple. Don’t spend anything. Ever.
The traditional way of saving focuses on spending less. That is ineffective (not to mention painful) for two reasons. First, because it is hard to track expenses. Especially because so much of our spending is in cash. Second, despite our best intentions, most of us are unable to resist spending when the temptation arises (e.g., that friend’s coworker’s birthday we MUST attend). So, at the end of every month (with the precision of a Swiss watch you can’t yet afford) we gasp at our bank balance, vowing to save more next month.2
A far more effective way to save? Save before you spend.
Warren Buffett said it best. “Do not save what is left over after spending. Spend what is left over after saving.” This isn’t just another quote from your family WhatsApp group that you can blindly delete. It is one of the most effective ways to save. And it is really, quite simple.
First, set yourself a monthly savings target. There are multiple ways to do that, which we will explore in later articles. The important thing is to be comfortable with that target. Commit to too much, and you will miss that target and be disappointed.
Then, right after your salary comes in, transfer that money from your salary account to another savings account. Why do we recommend a separate account? Because you’re far less likely to spend money from your savings account, than from your spending or salary account. This is due to a powerful psychological phenomenon called mental accounting. More on that next week.3 45
Even better, make that transfer automatic. That is a great way to overcome the self-control problems that will invariably crop up.
Then you can spend the rest guilt-free.
With this method, you will be saving every month without even thinking about it. Once you’ve made those savings, you can spend the rest of your money guilt-free. To me, that is the best part of the “save before you spend approach”. You don’t need to worry about whether you can afford those extra little luxuries. So go ahead, savour that coffee, enjoy that Uber ride.
Welcome to EasyPlan.
- That was a joke. It is not fun.
- Interestingly, research shows that we especially regret small, discretionary expenditures like coffees and Uber rides. Probably because we tend to justify the larger ones to ourselves. See Center for Advanced Hindsight. (2018). Learnings from the Lab: What Millennials Can Teach Us About Spending Thoughtfully.
- Thaler, Richard H. (1990). “Anomalies: Saving, Fungibility, and Mental Accounts.” Journal of Economic Perspectives, 4 (1) (193-205).
- Xiao, Jing Jian & I. Olson, Geraldine. (2009). Mental Accounting and Saving Behavior. Home Economics Research Journal. 22. (92-109).
- Maton, Cicily. (2018). How to Harness Mental Accounting to Instill Good Financial Habits. Interview by Jacob Meade, Wall Street Journal.