Chapter 2. The Power of Small Wins

ALOT OF advice that comes from personal finance experts is borderline condescending.

Why don’t you just spend less than you earn and save the difference?

Why don’t you just stop buying lattes from Starbucks every day?

Do you know how much you could save if you just gave up your Netflix subscription?

Just put your money in the stock market and don’t touch it. It’s simple!

There is a reason most financial advice doesn’t work: it makes people feel bad about themselves.

Financial advice sounds simple until you actually try it. Your finances can and should be simplified, but they are never easy because of the human element. There are so many choices to make that people can become overwhelmed. It’s difficult to know where to start, which accounts to open, which investments make sense and what to do with your money when you finally make the decision to save. And for many, simply coming to that decision can be the hardest part of the process.

I’ll start saving when I’m ready.

Save money!? In this economy!?

What’s the point of saving money when the system is rigged against me?

Have you seen interest rates lately? What’s the point?

It’s understandable that people are often so overwhelmed that they ignore their finances or focus so intently on the minutiae that they never get started in the first place. But just getting started is the key because small wins can help you train your brain to see positive results that can be turned into lasting habits.

Take the example of swimmer Michael Phelps, the most decorated Olympian in history. When coach Bob Bowman began working with Phelps, they experimented with the idea of starting small to get him in the right mindset. Bowman told author Charles Duhigg:

Eventually we figured out it was best to concentrate on these tiny moments of success and build them into mental triggers. We worked them into a routine. There’s a series of things we do before every race that are designed to give Michael a sense of victory.

The idea is that giving yourself a sense of victory helps you see progress, which in turn sets in motion a compounding of other small wins that eventually turns into a routine that can make you successful, and this turns into big wins.

The same is true when you’re just starting out as a saver. A team of researchers set out to help people save more money using the power of small wins. They discovered consumers were more likely to save when the decision was framed in terms of putting away £5 a day versus saving £150 a month. These numbers are basically identical, but more than four times as many people agreed to save £5 a day than those who promised to put away £150 a month.

How you frame these decisions can have just as big of an impact as the numbers used in your planning calculations. This same principle applies to paying off your debts. Once you get the ball rolling these things begin to snowball in your favour.

Let’s talk from personal experience.

Ben’s first job out of college paid $36,000 a year. After paying for rent, saving up for an engagement ring, paying back student loans and having a car payment for the first time in his life, there wasn’t much room left in his budget for investing. The small firm he worked for didn’t have a pension plan so after a year or so on the job he opened up a personal pension to begin his retirement savings journey. Since he couldn’t afford much he put just $50 a month into a target date fund at one of the low-cost fund companies. It wasn’t much money and it took a very long time to see results. But he took pride in the fact that he even opened up the account and soon it began to grow.

Over time as he made more money he slowly increased the amount saved. Every time he received a pay rise he would bump up his savings rate to avoid lifestyle creep and help juice his savings. It took many years to get his savings rate to where he wanted it to be. Making a higher income over time certainly helped, but the best thing he ever did to build good financial habits was just getting started. Those initial small wins set the tone to get where he eventually wanted to be in terms of saving because it helped develop the right habits.

The self-improvement writer James Clear shows the power of minor improvements in his book Atomic Habits:

The difference a tiny improvement can make over time is astounding. Here’s how the maths works out: if you can get 1% better each day for one year, you’ll end up 37 times better by the time you’re done. Conversely, if you get 1% worse each day for one year, you’ll decline nearly down to zero. What starts as a small win or a minor setback accumulates into something much more.

Getting just 1% better a day would make you 37 times better over the course of the year. This is easier said than done, but it shows how tiny improvements can have big results over time. No one starts out training for a marathon by running 26.2 miles on day one. The same is true for your savings.

Let’s say you start out saving 3% of your income with a goal of steadily increasing that rate in the future. If you go from saving 3% of your income in year one to 4% in the next, that’s a 33% increase in your savings rate. Go from 4% to 5% and you’ve given yourself a 25% annual jump in savings. Getting to 6% from 5% is a 20% jump.

The goal when you’re just getting started is to see an increase in your savings rate each year that is bigger than the historical return on the stock market (which has averaged 8% to 10% returns over the past 90 years or so) until you reach your steady state savings rate. (We’ll explain this in more detail in Chapter 5.)

For example, let’s say you are aged 25, you earn £40,000 a year and your monthly take home pay is around £2,400. You save 12% of that take home: £288. In the next year, you want to increase your savings rate by more than the historic return on the stock market (which has been 8% to 10%). A 20% increase in your 12% savings rate means you will now save 15% of your take home salary each month. You now save £360 per month (15% of £2,400).

It’s also important to start building good habits when you’re young to lessen the sting of saving more when you’re older. Psychologists have determined losses sting twice as bad as gains feel good. If you wait to start saving until you’re older, it will feel like lost income if those savings habits haven’t been developed yet. Therefore, saving money will make you feel twice as bad later in life because it will feel like you’re giving yourself a reduction in income.

Early on in your financial lifecycle, the vast majority of your gains will come not from your investing prowess but from your savings rate.

The next chapter will show you why.

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