Forced Savings: How to Save and Grow Wealth with Simplicity

Jake - Wealthy Corner Author/Founder

Jake - Wealthy Corner Author/Founder

Hi, I'm Jake. I help people under 40 reduce money stress and grow wealth.

Learn about the forced savings method so that you can save with simplicity.

Most fail to stick with a traditional zero-based budget.

Don’t give up if this is you. You just need a different approach.

Forced savings is an alternate method of saving money. I believe this method is ideal method for many. It is time-efficient and it doesn’t drain your self-discipline.

This leaves you with time and energy to spare for the important things in life. 

Infographic - Forced Savings

So, what is forced savings? 

What is Forced Savings?

Forced savings is when you transfer money to a savings or investing account immediately when you get paid. You proceed to spend everything that’s left.

This transfer can be done manually, or it can be automated through your bank with pre-authorized contributions. Forced savings works most smoothly when you are on a salary with a consistent and predictible income stream. 

Forced saving treats future you as a priority – you pay yourself first. Your savings can be used to:

  1. Pay down debt using the  debt avalanche method;
  2. Build an emergency fund;
  3. Save for an upcoming expense; or
  4. Invest to grow wealth.

Forced Savings Example

Josh makes $4,000/month after-tax. He receives two paychecks each month of $2,000 each. He sets up automatic transfers of $500 to his investment account to take place the day after each paycheck. 

This leaves Josh with $3,000/month to spend. Josh let’s his expenses naturally creep up to match this artificial income ceiling. 

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You May Already Be Using Forced Savings

You may be using forced savings right now. Here are two common examples: 

Mortgage payments. A large portion of a mortgage payment goes towards principle – increasing home equity, and your net worth. Plus, real estate has historically increased at roughly 1.3% annually above inflation, preserving your monetary worth. 

Pension contributions. Pension payments are automatically deducted from your pay for defined benefit or defined contribution plans. Those deductions are a form of forced savings. I have ~11% of my income removed from my pay for a pension. So, I live off 89% of my actual income. 

Lower Spending: Adaptation

Do you remember when you made 20% less than you do today? Has your wellbeing changed at all? Probably not.

You would would survive if you took a 20% income cut today, unless you struggle to afford food and shelter. Only the transition period would be rough.

You quickly adapt to our circumstances, and you’re more resilient than you think. A cut in spending will place a dent in your happiness for the short-run. But you will quickly revert to your level of happiness prior to the expense cut. 

And this works the same in the other direction. If you buy a new car, you’ll feel a temporary spike in happiness. But it will quickly fade, and you’ll revert to a baseline level of happiness.

This is called hedonic adaptation – we adapt to our increase or decrease in environmental circumstances, and revert to a baseline level of wellbeing. This is why I believe it’s important to do at least one hard thing every day. 

Read more: Money, Happiness, and Wellbeing: The Ultimate Guide. 

Forced Savings Made More Simple: Automation

Pre-Authorized Contributions

Pre-authorized contributions (PAC) can be used to automate forced savings. You can automate transfers to a savings account or an investment account on payday. 

Example time. Say you want to build an emergency fund. You can set up a PAC for $250 every payday to be transferred to a savings account.  

Six months has passed, and you now have a $3,000 emergency fund. Now that you’re emergency fund is full, you can instead transfer the $250 to an RRSP (IRA) or TFSA (Roth IRA). You can then buy investments within those accounts.

Automated Investing

You can even take it one step further by automating investments into a mutual fund of choice. This hands-off approach of forced savings and consistently investing into indexed funds will build wealth while you focus on the important things in life. 

Forced Savings and Investing

Consistent investing is the key to growing wealth (along with self-discipline). Once you have an emergency fund, any money you don’t need for the next five years should be invested.

Investing is made simple with stock/bond index funds that are in line with your unique risk tolerance.  

Here are three reasons why consistent investing, via forced savings, is great: 

  • You’ll naturally hit the market highs and lows of the market. This reduces attempts at market timing, while reducing risk. 
  • Human behavioral biases are reduced. The rigid system of investing removes emotional attachment to your portfolio. 
  • It maximizes time in the market. You invest as soon as money becomes available. This allows you to extract maximum benefit from compounding.

Index Mutual Funds and Indexed ETFs

 Funds that track the entire market have higher expected after-tax returns relative to actively managed mutual funds, with less volatility. Here are the reasons why:  

  • Low fees – Actively managed funds have high fees – 1% to 2.5% – that eat into returns. On the fees of indexed funds range from 0.03% to 0.25%. 
  • Efficient Market Hypothesis (EMH) – markets are fairly efficient, meaning all available information and risk are priced into a security price. This means to beat the market you need to have info that the other millions of people have missed.  
  • Low Turnover. Index funds don’t buy and sell the underlying stocks very frequently. That reduces transaction costs and improves tax efficiency. Active Funds, in comparison, buy and sell stocks frequently, generating high turnover.

To learn more about index funds I recommend you read this post and John Bogle’s Tiny Book of Common Sense Investing. 

Forced Savings: Watch Out for Credit Cards

A credit card can undermine your forced savings efforts when you pay off your credit card balance at the next payday. This makes it impossible to pay yourself first. 

I see two ways to fix this:

  • Create a negative credit card balance every payday. This sets your credit card spending limit. Next payday, load it up again. You’ll never pay interest.
  • Open a chequing or savings account that is used only to cover credit card expenses until the next payday. Pay off the card every payday and refresh the bucket. It keeps you paying yourself first. 

Credit cards aren’t for everyone, as they require discipline. Do you struggle with credit card use? If so, put it in the shredder, then buy everything with a debit card.

The Downside of Forced Savings

Time to break some news  – I don’t use forced savings.

I like to optimize every single dollar of spending. Therefore I aggressively seek out areas where I can cut spending without a decline in quality of life.

Forced savings doesn’t allow me to see where my money is going. It just sets an artificial income ceiling.

That’s why I do an expense audit every two months and turn this into a zero-based budget. And I recommend those using forced savings do an expense audit at least twice per year. 

Forced savings is a 95% solution. It offers sufficient control over your money and it is simple. I still recommend .

Conclusion

Forced savings is a simple way to spend less than you earn. This leaves you with more of your most valuable resource – time. You can now use this time to focus on life’s challenges. 

This personal finance game does not have to be complicated. It is simple – but hard. 

Automated forced savings and investing at consistent intervals is a simple system that can help you grow enormous amounts of wealth over time.