Let’s dive into a question that is becoming more relevant with the rise of various software tools and financial experts: “should you automate your personal finances?” Automation in personal finance is the gold standard, and rightly so. Make one good decision to eliminate 100 opportunities to make a bad decision. Set it and forget it. I truly believe in the power of automation. There is no better way to ensure that you achieve your financial goals.
However, just because it’s the best way to achieve your goals doesn’t mean that it works for everyone. Indeed, a Charles Schwab survey found that 74% of Americans are still not comfortable automating their day-to-day finances. That equates to about 194 million US adults.
When does automation work for your personal finances?
Automation functions best for those with reliable income that comfortably covers monthly fixed and variable costs. Additionally, automation can be applied incrementally – this isn’t an all or nothing situation.
Automating Expenses
Expenses tend to be easy to automate, with mortgage/rent payments, debt payments and credit card bills the most common culprits. Perhaps unsurprisingly, companies you owe money to will happily take it from your checking account automatically! This can be great for student loans, for example, as it removes the chances you’ll accidentally miss a payment. Alternatively, if you know you have extra cash available, you can automatically allocate it to pay down your debt faster.
Already, though, you might be thinking, “I’m not sure I want to automate my credit card payments every month”, and so we reach the first point at which automation doesn’t necessarily make sense for your personal finances. When it comes to variable expenses, automation can be challenging if you’re living paycheck to paycheck or have unreliable income. The flip side of this is of course that by not automating credit card payments in full, you are implicitly anticipating borrowing money at an incredibly high interest rate.
Automating Incomes
This is when automation really starts to go to work for you. Once you have enough income to comfortably cover your expenses, you can start to direct your leftover income automatically.
There are two main categories for this type of automation:
- Saving
- Investing
For most Americans, a 401(k) contribution is usually the first thing to be automated. Many companies now have an auto-enrollment system for contributions. The default option for employees is to have a certain percentage of salary taken out of your paycheck and put towards a 401(k) plan. There is lots of research showing the benefits of this approach.
Other areas of personal finance that you can automate include:
- Transfers to savings accounts
- IRA contributions
- Brokerage account contributions
- Investment purchases within investing and retirement accounts
Ultimately, this level of automation makes it very simple to achieve your financial goals. You can direct just about all of your income and put it to work if you can be certain of your next paycheck.
When does automation fail?
For the vast majority of people, fully automating finances isn’t an option. Student loans and/or housing costs are the most common automations that people do set up. However, for many, there is no opportunity to automate any of their personal finances. According to a June 2021 report, 125 million American adults live paycheck to paycheck. This is not a recipe for success when it comes to relying solely on automation to achieve your financial goals.
This is a huge issue, and ties to the steady departure of the ultra-wealthy from the less well-off masses in many developed economies that we’ve seen in recent decades. Automation is widely accepted as the best practice for personal financial success. It works very well for wealthy people who can comfortably cover their expenses and meet financial goals each month. Wealthy people also tend to be those who invest in early-stage startups that could address the limitations of automation. Because many wealthy people have experience with the success of automation and deeply understand its benefits, they invest in companies that focus on it.
Unfortunately, these fantastic startups that do a great job of automating personal finances, then further leave behind the majority who aren’t in a position to automate their finances. Unfortunately, the majority of society isn’t served by these products, which only serve to further enrich those who are already in a position to take advantage of automation. So the wealth gap is exacerbated, and upward socioeconomic mobility, already declining and at historic lows, becomes harder still to access.
How do we address the limitations of automation in personal finance?
So what to do about it? Will better integrations in apps like Mint and Personal Capital that more accurately categorize transactions improve things? What about algorithms that suggest a more risk-appropriate portfolio allocation?
We need to build products that serve the majority of the population that actually help them achieve their financial goals. Automation is great, and should be the ultimate goal for everyone. However, the reality is that many people can’t, or don’t want, to automate most of their personal finances. Those people need a tool that offers them the chance to get from A to B, not 0 to 100.
Money Pools
One approach to financial goal achievement that has been very effective over centuries in many societies and cultures is money pooling. In a basic money pool, a group of people decide to pay into a common pool, a certain amount of money over a given period of time. Let’s say, for example, that 50 people decide to pay $100/month into a money pool for 12 months. At the end of the year, the pool will hold $60,000. Each member will have saved $1,200.
These money pools have proven significantly more effective than saving by yourself, due to the social accountability provided by each member of the pool. Here we find the extrinsic motivation that is one key to achieving goals. We also know that this approach serves those at the lower income levels. Indeed, most money pools in the US are operated by lower-earning immigrant communities. What’s the default rate for these types of savings vehicles? According to a study by Carlos Velez-Ibañez, the rate of non-payment is 0.005% of total funds.
The Failure of Automation
For decades now, reams of information around what you “should” do with your finances have been widely accessible. Automation of finances has been around since the dawn of the internet age. Yet here we sit in 2022 in a society where 60% of Americans couldn’t cover a surprise $1,000 expense using savings.
It’s time for a new approach. My belief is that social accountability is the key to unlocking financial goal achievement for the majority of the population. Of course it isn’t the only factor. It will be most effective when paired with educational content and resources served at the relevant time. However, the right combination of intrinsic and extrinsic motivation is key to goal achievement. Until we apply that to personal finance, all the automation and information in the world isn’t going to make the difference we need it to.
Conclusion
Social accountability is not the only answer here, in the same way that automation isn’t the answer to personal finance. There are deeply ingrained systemic issues that make financial success harder to achieve for large swathes of Americans (and many other countries). That being said, by encouraging financial community and social accountability, we can provide a pathway to goal achievement that serves a vast majority of people. By promoting the gold standard of automation as the only pathway to financial success, we immediately exclude 74% of US adults. We must make personal financial success more attainable. I believe building a community is where we start.
Read more about why automation in personal finance isn’t the holy grail.
