Oaths to quit smoking or start exercising “tomorrow” rarely pan out. But there’s one “I’ll do it later” promise you can make that research suggests will pay off in better financial health: setting up automatic bill payments and savings bumps.
The reason we kick the can down the road in the first place is often because we have low willpower and "present bias" — the human tendency to favor immediate payoffs over long-term gains. Setting up automatic payments helps you sidestep that bias and, in turn, boost your finances. Rather than having to pay your bill or increase your retirement contributions today, you agree to have your financial institution or, in some cases, employer, do it later.
Here are some ways to use automatic payments to reduce the power of present bias, based in part on research from behavioral economists Shlomo Benartzi and Richard Thaler, who is also a Nobel Prize winner. These tips may help you reduce debt, improve your credit score and grow retirement savings.
Pay bills with automatic payments. Set up automatic payments for all regular expenses such as utilities, housing and credit card or loan repayments. (Contact your financial institution if you’re unsure how to do this.) Time the transactions to coincide with paydays so you’re not tempted to spend too much of those deposits before paying the bills.
With automated payments, you’re more likely to pay bills on time and protect your credit score. There are five basic metrics used to calculate your credit score, and prompt payment history is one of them.
Set a larger monthly payment for high-interest debt. Make at least minimum payments on all credit cards, but consider setting up automatic payments for an amount that's double or triple the monthly minimum on higher-interest debt. Or pay more toward the account with the highest balance. That will lower the total amount of credit you are using, known as credit utilization, which is another big factor in your credit score.
After getting high-interest debt under control, it’s time to start paying yourself.”
Automatically put part of your pay in a savings account. After getting high-interest debt under control, it’s time to start paying yourself. Arrange with your employer or bank to automatically transfer a set amount from your paycheck to your savings account. This will help build your emergency savings fund, which will reduce the need to lean on high-interest credit cards when your car or home needs repair.
Auto-escalate your retirement savings. Many companies now offer a program that automatically raises your 401(k) contributions, typically 1% a year, until you reach a preset limit. Your employer also may offer the SMarT (“Save More Tomorrow”) program, developed by Benartzi and Thaler, where regular contributions automatically increase with every pay raise.
Both programs require you to opt out to leave, so the power of inertia — or, as Benartzi and Thaler wrote in a 2017 Wall Street Journal op-ed, “our tendency to accept the status quo” — now swings in favor of increased savings.
Automate monthly payments to tax-advantaged IRAs. After you’ve contributed to your 401(k) or another employer-sponsored retirement plan enough to get employer match, a move to consider is opening a traditional or Roth individual retirement account. Set up automatic payments to max out your $5,500 contribution per year ($6,500 if age 50 or above).
We can all be lazy when it comes to changing financial habits. By automating savings increases, however, we can finally profit from our tendency to procrastinate.