Developing good money habits is vital for financial stability. But, it's not always easy. With some help, you can enhance your financial well-being by adopting proven techniques from renowned experts such as James Clear, Charles Duhigg, and Chip and Dan Heath.
This comprehensive guide covers everything from setting SMART goals to automating savings, providing a roadmap to financial independence. These time-tested financial habit-building strategies will empower you to achieve your financial objectives: eliminating debt, saving for the future, or building generational wealth.
How to create a lasting money habit
Breaking bad financial habits can be tough, but the payoff is huge. Luckily, there is extensive research and ideas out there that can help. Let's borrow some strategies from “Atomic Habits” by James Clear, “The Power of Habit” by Charles Duhigg, “Switch” by Chip and Dan Heath, and Nudge: Improving Decisions About Health, Wealth, and Happiness” by Richard H. Thaler and Cass R. Sunstein.
Let's explore how these concepts can be applied to personal finance, particularly in the context of setting up automatic savings or investment plans.
Examples of creating change
“Nudge” is centered around the concept of “choice architecture,” which is the idea that the way choices are presented to people affects their decision-making. Thaler and Sunstein argue that subtle changes in how options are presented can “nudge” individuals towards making better decisions, without removing their freedom of choice.
Automatic Savings: By setting up automatic transfers to a savings or investment account, you're using a nudge to create a beneficial financial habit. The nudge here is the automation – it simplifies the decision to save and invest, making it a default action rather than a choice that requires active effort.
Opt-Out vs. Opt-In: Making saving and investing an opt-out process rather than opt-in (where money is automatically saved unless you choose otherwise) significantly increases the likelihood that people will save.
James Clear's advice is all about starting small. Instead of overwhelming yourself with big financial goals, make tiny changes that add up over time. Create systems that naturally make you better with money. Position yourself as someone smart about finances, rather than someone struggling.
Charles Duhigg introduced the habit loop: cue, routine, and reward. Figure out what sets off your spending habits (cue), then swap out those impulse buys with better routines. And don't forget to reward yourself, but not necessarily with money-related treats.
“Switch” explores how to change things when change is hard. The Heaths introduce a framework involving the Rider (the rational mind), the Elephant (the emotional mind), and the Path (the situation or environment). Essentially your mind has a logical and emotional side. Use both to your advantage. Understand why good finance habits matter logically, and then get excited about the benefits emotionally. Also, make it easier for yourself by setting up your environment to support those new habits.
– Direct the Rider: Set clear, specific financial goals. For example, “Save $200 per month for retirement.”
– Motivate the Elephant: Connect your financial goals with emotional outcomes. Remind yourself how saving secures a comfortable future or allows for a desired lifestyle.
– Shape the Path: Make saving the easiest option. Automatic transfers reduce the effort and decision-making required, aligning with the “Path” aspect of the Heath brothers' model.
To create an environment conducive to good financial habits:
1. Set Clear Goals (Direct the Rider): Decide on your saving or investing goals.
2. Emotional Connection (Motivate the Elephant): Understand why these goals are important to you on an emotional level.
3. Automate the Process (Shape the Path): Use the nudge of automation to make these goals easier to accomplish.
Let's break down these ideas into smaller, actionable bits.
Better financial decisions: 10 money habits to grow
1. Set SMART money goals for financial success
Setting SMART goals is like having a treasure map for your finances. It helps you navigate towards your dreams in a clear and achievable way. SMART stands for Specific, Measurable, Achievable, Realistic, and Time-based, and here's why it works.
Imagine you have your eyes set on buying a house. You want to save up $20,000 for the down payment. Using SMART, you break it down like this:
- Specific: You know exactly what you're saving for – a house down payment.
- Measurable: You keep track of your monthly savings to ensure you're on target.
- Achievable: You set monthly savings goals that fit your budget.
- Realistic: You look at your spending habits and find ways to save money without sacrificing too much.
- Time-based: You give yourself a deadline to reach your goal in 3 years.
Applying this SMART financial plan means you're not just dreaming about your future home but actively working towards it. It keeps you focused and accountable and gives you a clear path to follow on your journey to financial independence.
2. Establish emotional motivation for each goal
Whether they are short term goals are long term goals, you need to understand the root cause of their importance. If the goals don't matter to you at a deeper level, you'll have a hard time connecting the dots. Gettin clear with your motivations will help you feel confident about the path to achieve them.
3. Set up and follow a personal budget
Managing your finances effectively involves setting up a budget and keeping track of your expenses. This approach helps you understand where your cash is going and ensures you're not spending more than you earn. That way you don't just get your paycheck and then spend it.
Tracking expenses allows, you to gain control over your finances, make informed spending decisions, and save money for emergencies and future goals. Apps like Qube Money help with budgeting by digitizing the cash envelope system, giving users more control over their finances and making better spending decisions.
4. Contribute to your savings account early and regularly
Saving early maximizes the potential of compound interest, often called the “eighth wonder of the world.” It allows your money to grow exponentially over time, as you earn interest not just on your initial investment but also on the interest it earns. The longer your money is invested, the more time it has to compound and increase in value.
Explore banking apps and tools such as Simplifi and Qapital that can help automate the saving process to ensure you consistently put money in your savings account.
5. Reduce high-interest debt
Minimizing high-interest debt is a key financial strategy that can significantly lighten the burden of debt payments, allowing you to save more and clear your debts faster. High-interest debts, like those from credit cards, often come with hefty interest charges that can quickly spiral out of control due to compound interest.
High-interest debt can eat into your income, making it tough to build emergency or retirement savings. Plus, it can trap you in a cycle of debt that's hard to escape.
Here is what you can do:
- Ask your credit card company for a lower interest rate, especially if you've been good with payments.
- Transfer your balance to a card with a lower rate or even a 0% introductory offer to slash those interest charges.
- Plan to pay more than the minimum monthly to chip away at the principal faster and save on interest in the long run.
- If you have multiple debts, prioritize paying off the ones with the highest interest rates first while still making minimum payments on the others.
- Consider consolidating your debts into a single loan with a lower interest rate to make managing and paying them off easier.
6. Pay bills on time
Paying bills on time, or even ahead of schedule, can save you from unnecessary fees, lower interest charges, and maintain a strong credit score. It's not just about meeting deadlines; it's about safeguarding your financial future.
And let's not forget about the practical side – paying bills on time helps ensure you don't face any interruptions in essential services like electricity or internet due to missed payments. You can use bill pay apps like MoneyPatrol, which alerts you to approaching bill due dates.
7. Spend less than you earn
Spending less than you earn balances your expenses and income, allowing you to save and invest the surplus. Living within your means helps you steer clear of piling up debt. It also allows you to build an emergency fund, providing a safety net for unexpected expenses. It also opens up doors for investing in opportunities to help you grow your wealth over time.
8. Regularly review and optimize insurance plans
Checking your insurance plans guards against the risk of being underinsured or paying excessively for coverage you no longer require. This proactive practice ensures your protection aligns with your evolving needs and life changes.
Life events like marriage, the arrival of a child, or home renovations can alter your insurance needs. Conducting an annual review allows you to adjust your coverage accordingly, ensuring you're adequately protected. This money habit also presents an opportunity to explore potential cost savings, such as qualifying for discounts or securing lower premiums based on changes in your risk profile or market conditions.
9. Analyze and track your food expenditures
When you prepare meals at home, you have greater control over both the cost and quality of ingredients, unlike dining out where you're paying for service, ambiance, and restaurant markups.
Cooking at home empowers you to manage your expenses more effectively while ensuring the ingredients meet your standards. By avoiding the markups typically imposed by restaurants, you can stretch your dollars further, leaving more room for other financial priorities in your budget.
10. Ask for help
Talking about money isn't easy, but you can consult online resources or financial experts for valuable insights and guidance. A knowledgeable source or financial advisor can steer you away from common pitfalls, and empower you to make sound financial decisions that align with your financial goals.
11. Automate everything
Putting your financial moves on autopilot, whether it's regularly investing or saving takes the decision making out of the equation.
Cultivate and maintain good financial habits
Make a habit of improving your habits! Sounds a bit meta, but reinforcing good financial habits cements the behaviors that lead to lasting financial success. Consistency in these habits not only strengthens your financial health but also enhances your ability to achieve your financial objectives quickly.
Consistency turns sporadic actions into steady routines, making sticking to your financial plans easier. It also instills discipline, helping you avoid impulsive financial decisions that could derail your progress. You'll consistently move towards your financial goals, whether big or small.
FAQs
What is the 50 30 20 rule of savings
The 50-30-20 rule is a budgeting guideline that suggests allocating 50% of your after-tax income to needs, 30% to wants, and 20% to savings and debt repayment1.
What is the 70% rule for saving
The 70% rule for saving, often referred to as the 70-20-10 budget, suggests using 70% of your income for monthly expenses, 20% for savings or debt repayment, and 10% for donations or additional debt payments
What is the 20-30 rule for money?
The 20-30 rule for money seems to be a variation of the 50-30-20 rule, which is a budgeting method where you allocate 50% of your income to needs, 30% to wants, and 20% to savings.
What is the 30-day rule?
The 30-day rule is a spending strategy that advises you to wait 30 days before making a non-essential purchase to avoid impulse buying and to consider if it aligns with your financial goals.