“I’m takin’ control of my life now.” – Tom Petty
Jim Shellenberger, CFA | Financial Advisor
In Tom Petty’s song “Two Gunslingers,” two gunfighters in the street realize they don’t want to fight anymore. As a concept, it is very much like the dilemma many of us continually face when we battle regarding how much to spend today versus how much to save for the future. Self-control bias is an emotional bias that causes people to fail to pursue their long-term goals1. When it comes to managing one’s finances, people often have difficulty sacrificing present-day spending due to a tendency to prefer small payoffs today instead of waiting for larger payoffs in the future. But self-control bias is not only applicable to finances. Take physical fitness, for example: committing to a long-term lifestyle change, which involves permanent adjustments to one’s eating and physical exercise, is not as easy as continuing to do what we are currently doing.
It seems that most people do not consciously realize the decisions they make when they choose to enjoy the present moment at the cost of securing their longer-term well-being. For many, consumption today is financed with a loan from their future happiness. Perhaps the reason is simply that life is busy, and when we are not consciously thinking about how much we can be spending and what we should be saving, it is easier to opt for instant gratification and to consume. But the actual price tag of the products and services we buy today will, unfortunately, only become apparent somewhere down the line. So, what if we decided that right now is the time to become conscious of our decisions? What kinds of actions would it require to take control of our lives? Let’s explore.
Kicking the can down the road doesn’t work quite like we would hope. If we are honest with ourselves, I bet most of us have thought that saving will become easier in the future, when we make more money. While theoretically speaking this could be true, it rarely works out quite like expected. Factors such as taxes, lifestyle creep, and 401(k) contributions can eat up at the added income quicker than we imagine.
Here’s an example: a couple’s joint income is $100k a year, they are in the 22% tax bracket, they contribute 10% to a Roth 401k, and they get a raise of $20k. Now they have $20k more to spend a year, right? Unfortunately, this is not the case.
|Roth 401k Contribution (10%)||($2,000)|
|Take home amount||$13,600|
|Amount per month||$1,133|
In addition to the added expenses detailed above, there is another crucial piece we have not taken into account. Lifestyle creep – defined as the phenomenon where, as our standard of living improves, our consumption of non-essential items increases. For our example couple, lifestyle creep means thinking that with their $20k raise, they can now spend money a little more freely. Perhaps they eat out a little more often, go on a vacation, and purchase a new car. How do these seemingly minor changes compare to the $20k raise?
|Extra Monthly Income||$1,133|
|Eating out / indulging ($200/month)||($200)|
|$4k vacation ($333/month)||($333)|
|New car (monthly payment of $600)||($600)|
|Amount of raise left||$0|
“Take control” of saving. If my hypothesis is correct in that most people struggle with self-control bias simply because they are not attentive, then the solution should be…well, paying more attention. What does being attentive look like in finances, then? The answer varies from person to person. Some people need to have their expenses budgeted down to the dime, while others are fine planning their spending and saving by painting with a broad brush. The one thing that everyone wishing to be in control of their spending and saving habits needs, though, is determining how much they plan to save.I know what you are thinking. “with our increased pay, we now contribute more to our Roth 401(k). That’s more saving!” But if we attempt to increase the percent of our income we save, we are not making any progress. For example, the family may be striving to save 15% of their income yet are currently stuck at 10%.
The easiest way to go about this is to prioritize where you want your money to go. Whatever your most important goal is – whether it’s the house payment, saving, or philanthropy – put it at the top of your list. After that, simply work your way down in importance. This way, the items that mean the most to you will be taken care of first, and the things that mean less to you may get cut out or trimmed. Once you have your order of importance figured out, automate what you can: have your house payment made automatically, direct your planned amount of money to go to a savings account or investment account monthly, with no additional action required, or set up an auto-pay for your donations. Your system will make sure your money goes in the places you deem most important and leaves you to spend what is left however you like.
How do we get there? There are varying guidelines as to what percentage of your income you should be saving each month, and the estimates usually range from 15 to 25% or more. Your financial advisor can help you figure out the right number for you, as there are factors like age, current savings, and living expenses that come into play. The goal is to find a balance. You don’t want to spend all your money today and struggle in the future, but you also do not want to save every dime when the future is not promised. If you feel you should be increasing the percentage you save but are intimidated about doing it, make incremental changes. For example, if you are currently saving 10% but would like to get to 15%, try bumping up your savings by 1% every quarter. If you can go all the way at once and set aside the additional five percent right away, go for it. But even if you can’t, don’t let that deter you. Baby steps are steps, too, and taking them will likely contribute to where you want to be.
Everyday life is a series of decisions between what is best right now and what is best in the future. Finances are no different. It is good to remember that the present and future well-being do not have to fight each other and that it is possible to find a balance between what is best both today and in the future. But for that, we need to be attentive to what we are doing and “take control” of our lives.
Ready to talk?
Please reach out to set up an appointment.
- Pompian, M. (2017, September 21). How to help clients overcome self-control bias. Retrieved May 12, 2021, from https://www.morningstar.com/articles/832959/how-to-help-clients-overcome-self-control-bias
Past performance is no guarantee of future returns. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any types of securities and no investment decision should be made based solely on information provided herein. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for an s investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. All performance results should be considered in light of the market and economic conditions that prevailed at the time those results were generated. Before investing, consider investment objectives, risks, fees and expenses. Please contact a tax professional for advice on your individual circumstances and tax consequences.
Information provided herein reflects Elevate’ s views as of the date of this newsletter and can change at any time without notice. Elevate obtained some of the information provided herein from third party sources believed to be reliable, but it is not guaranteed, and Elevate does not warrant or guarantee the accuracy or completeness of such information. The use of such sources does not constitute an endorsement. Elevate’ s use of external articles should in no way be considered a validation. The views and opinions of these authors are theirs alone. Reader accesses the links or websites at their own risk. Frontier is not responsible for any adverse outcomes from references provided and cannot guarantee their safety. Elevate does not have a position on the contents of these articles. Elevate does not have an affiliation with any author, company or security noted within. Elevate reserves the right to remove these links at any time without notice.
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries or financial instruments of any kind. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment or tax advice.
Information provided herein reflects Elevate’ s views as of the date of this newsletter and can change at any time without notice. Elevate obtained some of the information provided herein from third party sources believed to be reliable, but it is not guaranteed, and Elevate does not warrant or guarantee the accuracy or completeness of such information.
Elevate Asset Management is wholly owned and operated by Frontier Asset Management, LLC. Frontier’s ADV Brochure and Form CRS are available at no charge by request at firstname.lastname@example.org or 307.673.5675. The ADV Brochure contains important disclosure information and should be read carefully. 051221CST053022