“It’s not how much you make, it’s how much you keep.” —Robert Kiyosaki, Rich Dad Poor Dad
The balance in our investment account wasn’t getting any bigger. I’d studied the ways of wealth building and knew what to do. I had tattooed the “pay yourself first” principle on my brain. We had a budget, and right there at the top was a line item for setting aside 15 percent. Still, every month, there seemed to be something “unexpected” that would pop up and derail our efforts to set aside money for investing.
In The Total Money Makeover, author Dave Ramsey suggests that success with money is 20 percent head knowledge and 80 percent behavior. That seems about right. In my experience, most people at least have an idea of what they’re supposed to do with money. Some of us even study it extensively. And I know for a fact that good money habits are not rocket science. But actually doing what needs to be done can seem very difficult—at times, impossible.
Even with the best of intentions, it takes more than knowledge. Sometimes, we need to actually fool ourselves.
When it comes to mindset for growing our wealth, we need to abandon the “fixed pie” or scarcity mentality: the belief that there is only so much money to go around. According to this worldview, if one person has more money, then it must have been taken from someone who now has less. Instead, we must replace this thinking with an abundance mentality: the belief that there is more than enough money in the world for each and every one of us to prosper and become wealthy. (There is.)
But while the abundance mentality is effective when thinking about how to earn money, it is exactly the wrong approach to managing the money that you have already earned. If you believe that money is easily replaced, then you will also spend more freely. Easy come, easy go.
A simple concept from the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko has laid the foundation for our approach to managing our money. Stanley and Danko studied the very question of how the wealthy manage their finances:
“How did they become millionaires? How do they control spending? They create an artificial economic environment of scarcity for themselves and the other members of their household” (Stanley 41).
When managing the money that they have already earned, the wealthy tend to adopt a scarcity mentality. In other words, we need to trick ourselves into believing that we earn less money than we actually do.
In this article, I’ll explore a number of ways to do just that.
1. Siphon money at the source.
Probably the most popular and widely adopted method of reducing income is to siphon it off at the source. With authorization, many companies will automatically make contributions to retirement accounts on behalf of employees. This means that the money has not only been set aside, but also invested, before ever reaching the employee’s bank account. Let’s face it, whatever money is in your bank account is at risk of being spent.
This approach to saving and investing allows you to make a good logical decision for your future when you are being rational. Later, when emotions get involved (“I deserve it”) you simply don’t have the money available to spend.
Some employers will actually allow you more options than just putting money in a retirement account. What if you want to save up a deposit for a rental property? Check with your HR department to find out whether you can siphon off additional funds into a savings account. Just be sure that you don’t have easy access to this account or that there are penalties for withdrawing money frequently and unnecessarily. Otherwise, all you will have managed to do is create an additional spending account.
2. Scale up your savings with your pay.
One of the advantages of siphoning off money at the source is that you can often set it up as a percentage of your pay. Whenever I’ve done this, I’ve had to fill out a form with HR/payroll. On that form, I’ve usually had the option to specify a dollar amount or a percentage. If you choose to set aside a percentage of your income, then, as your income grows, so will the amount that you set aside.
So, if you want to pay yourself first and set aside 15% of your pay, probably the easiest way to do this is to go into your HR department and fill out the form. The rest is automatic.
Because of just how easy and effective this approach is, I highly recommend it, especially if you’re struggling to get started with any savings and investment. The reality is, if you’re not controlling your budget, then you probably won’t even notice that the money is no longer coming into your account. Ironically, people on a strict budget are more likely to notice the difference.
3. Crush your mortgage.
Perhaps you are setting aside money for an investment, but there aren’t many good opportunities just now. Some big-time real estate investors will tell you that there are always opportunities. Maybe they’re right. But in the few years that I’ve been at it, I’ve observed that the market operates in waves. When it crests, prices are high and it’s usually a terrible time to purchase a cash flowing property. When the market troughs, however, prices are low and it’s time to buy. If you are in a crest, waiting for a trough, your money will be building up in your bank account. The problem with this is that you’ll earn interest on this money and then owe tax on those earnings. This makes no sense if you also have a mortgage payment for which you’re paying interest.
It might make sense to ride out a market crest by paying down your debt. This allows you to get yourself in a better financial position by converting cash into equity and reducing debt. It saves money in interest payments. You can always borrow money against your home later with a Home Equity Line of Credit (HELOC) when the time is right for buying.
But beware: Paying your mortgage is not the same as investing. Taking this approach might make sense for a while. But it could tie up your funds if the bank won’t allow you to draw on your home equity when you’re ready to invest.
Always keep in mind that investing is the higher priority—you must plant seeds to grow a forest.
4. Set aside that phantom paycheck.
Do you get paid every two weeks? If most of your bills go out monthly, then you are probably tempted to average out all 26 of your paychecks over the course of a year and then divide those across 12 monthly budget periods. This is technically correct.
However, most months you will receive exactly two paychecks. Then, once every six months, it feels like you win the lottery when you receive an extra paycheck. If you’ve been counting on this paycheck, then your financial situation will likely feel like a rubber band: Your finances stretch tighter and tighter until this extra paycheck finally appears and the tension is released.
A better tactic is to build your monthly budget based on what you bring home in two of your bi-weekly paychecks. If you can live on this amount, then every 6 months, you will receive an extra paycheck that can be set aside for investing. This would amount to 7.7% of your take home pay. This may not seem like too much, but if you also siphon off, say, about 7.5% of your income into a retirement fund before your take home pay then combined, you’d be setting aside more than 15% of your income. Using several of these incremental approaches in combination could really help you to get where you’re wanting to go.
5. Invert the usual approach of investing only a percentage of your bonus.
Throughout my career, my employers have tended to pay out a modest annual bonus. I am very grateful for it. Still, it has usually been roughly equivalent to a phantom paycheck. This means that it’s also been pretty easy to just spend it. But when I consider what it could have amounted to had I invested the money, the only correct action is a face-palm.
These days, if and when I get a bonus, I usually take my wife out for a nice dinner and bank the rest of it in our investment account. This way, I invert or flip the usual approach of investing a percentage off the top; I only take a small portion off the top for spending while leaving the rest for investment.
Related: 4 Steps to Finally Tackle Your Debt—and Start Growing Real Wealth
Also, if you are siphoning money off at the source for a retirement fund or other investment savings, check with your employer to ensure that this applies to your bonus payments as well. This way, paying yourself first applies to all of your income, not just your standard paycheck.
6. Live on one income.
Do you have a dual-income family? Try putting together a household budget based on only one of the two household incomes. Set aside the second income for investment.
This may seem like a real challenge, but there are times in life when you must adopt this approach anyway. When my wife went off work to have our children, we were forced to adjust our lifestyle to fit within my paycheck. To do so, we got ourselves on a relatively strict budget. As my wife started back to work part-time, we chose not to increase our lifestyle to absorb the additional income. Instead, we set it aside for investing. As our kids head off to school, my wife is starting to work more hours. Because we are set up this way, rather than just spend more, we are poised to supercharge our investing instead.
Even if you and your partner both have steady incomes, this can be a great strategy. It will obviously be easier to adjust your lifestyle initially to live on the higher of the two incomes. This is a great start! But if you want to challenge yourself further, consider whether you can budget your lifestyle to live on the lesser of the two incomes. If you can achieve this, then not only will you be setting aside a significant chunk of money for investment, but you will also create resilience to the temporary loss of either income.
In our case, my wife earns an hourly wage. If, for any reason, she works fewer hours in a given pay period, this reduces the amount that we bring in. In contrast, I earn a salary. This makes my pay more consistent and easier to budget around.
7. Live on one semi-monthly paycheck.
Want to really challenge yourself? Let’s say you get paid twice monthly, on the 15th and last day of each month. Ask yourself a simple question: Could you live on just one of those two paychecks?
For some, this may seem impossible. But I wish I had asked myself this question when I was young and single. If I’d tried, I’m sure I could have figured out a way to answer “yes.” Instead, I spent it all when I could have been putting aside 50 percent of my income.
8. Don’t grow into your new income.
Do you find yourself in the situation of having a sudden and significant increase in income—for example, a new job or a promotion that brings with it a significant jump in pay?
Ask yourself this question (or discuss with a partner): Can we be happy with our lifestyle exactly as it is today? Do we have any outstanding needs that must be fulfilled right now? For example, if you have children and are living in a dangerous neighborhood, maybe you should think about using your change of situation to provide a safer environment for you and your family.
But if you’re living in an acceptable neighborhood and you’re relatively happy, then maybe you can forego the extras. Sure, you’d love to have a bigger, nicer house, and more luxuries like a new car, and a big TV. But you’re actually doing fine.
Let’s say you’ve been earning $55,000 (a rough U.S. household median income using 2014 numbers), and you just got a 10% pay increase by switching to a new job. That’s a gross increase of $5,500 before taxes. You will pay about 25% in taxes on the increase, leaving you with $4,125. If you are contributing to your retirement account at 10% of gross income then that contribution will increase by $550 annually. (See, you’ve already scaled.) This leaves you with $3,575, or about $298 per month.
This is where you need to get tough on yourself. Instead of using that money to increase your lifestyle now, ask yourself if you can be happy living as you are and instead set that money aside each month for investment. Perhaps you want to build up a fund to save for a deposit on a rental property. It could take a few years, but this is your chance to get started. Start setting that money aside. If you are more keen on stocks, then you could use that money to start creating a stock portfolio.
As an aside, always round up. That extra $298 per month available would prompt me to start setting aside $300 per month. It may not seem like much, but it forces you to shave $2 from somewhere else in your budget. This kind of trimming, done regularly, keeps you living a more lean lifestyle while you are building investments.
Sometimes you really do need to use additional money for day-to-day living. When I received my most recent annual incremental increase, I wanted to funnel all of the money into either our investment account or put it against the mortgage to pay it down faster. But my wife told me we needed money for other things. Our small children are growing up and starting to eat more; we were starting to run short on our grocery budget regularly. And we’re not exactly feasting like royalty. In addition, all of our insurance premiums went up, as they do every year. Pretty quickly, my incremental pay increase incrementally disappeared.
But because we siphon some money off at the source and this scales with our incomes, we at least managed to reap some benefit from the pay increase. And since we combine several of these approaches already, we can accept it when life occasionally does get a little more expensive.
As always, if you have consumer debt—anything other than your home mortgage—then you should first use any extra money toward paying off those debts. Once you have eliminated consumer debt, you have the opportunity to start saving for investment.
Any strategy you can adopt to fool yourself into setting aside more money for investment is a huge step forward. Combining several strategies compounds the effect. Creating an environment of artificial scarcity is a great way to trick yourself into becoming wealthy.
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What method do you use to set aside more money?
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