Compare two people trying to get an edge in life after starting with debt.
John focuses on small wins: removing little costs wherever possible. He sets up a budget. He cuts back on his daily lattes. He doesn’t buy new clothes. He doesn’t go out much.
Chris focuses on big wins: a few things he can do once that will pay him back forever. He negotiates multiple salary increases, including a $20,000 raise. He negotiates his rent from $2,000 per month down to $1,500 per month.
What’s the difference between the two?
Chris is, in fact, a real person. A national reporter wrote about him in a six-page Fortune profile. Today, he earns $120,000 and has tens of thousands in savings. He leveraged the philosophy of big wins to do a few easy things that got him a life-changing impact. As a result, he can now do the things in life that make him feel rich.
John isn’t a real person, but he represents the conventional wisdom of finance experts: frugality. No lattes! No new clothes! No appetizers! Constantly say no to all the little expenses. This approach fails because it requires you to build a difficult habit that you keep for life. We deplete our willpower every time we say no to the little things in life that make us feel rich. This is the reason why many people who try this approach eventually give up.
My team and I have spent the last 12 years searching for these big wins, testing which ones actually work, and teaching them to tens of thousands of students in my courses and to millions of readers on my blog.
The best personal finance big win that we’ve ever come across is automating your finances. By automatically managing your money month after month with a system, you work with your psychology instead of against it. As a result, you save money for your retirement and for guilt-free spending.
With this big win, if you take the average American household income of $72,641, you’d save $726 a month for the rest of your life.
Here are the exact steps you need to take so your money automatically flows to where it needs to go:
Automatically invest 5 percent of each paycheck into your 401(k)
First, you want to set up a monthly automatic deduction from your paycheck to your 401(k). Not sure how much you should be sending? A good rule of thumb is 5 percent.
Why a 401(k) and not a regular, taxable investment account? With regular, taxable investment accounts, you pay taxes on your income before you can invest it. So for every $100 you make, you might actually only be able to invest $85 of it. Fifteen percent (or whatever, depending on your tax rate) goes to the tax man.
With a 401(k), you can invest the entire $100 and let it grow for about 30 years. That extra ~15 percent turns out to make a huge difference as it gets compounded over time.
You absolutely, positively need to participate if your employer offers a 401(k) match. This is free money! A 1:1 match of $2,000 means that your company will match every dollar you invest up to $2,000. Therefore, investing $2,000/year really means you’re investing $4,000/year. Whoa.
It doesn’t matter what kind of debt or expenses or whatever you have — if your company offers a match, do it.
Simply go to your HR person and say, “Look, I want to contribute every month. Can you help me set up an automatic deduction?”
Automatically direct deposit your paycheck into your checking account
While you’re chatting with HR about your 401(k) also tell them that you want to set up a direct deposit for your paycheck. Setting it up typically involves filling out a short form and attaching a voided blank check.
Why direct deposit? One, you really don’t want to have to go to your bank every month to deposit your paychecks. It’s just a pain. Two, when you set up direct deposit, you are actually going to get a bunch of benefits from your bank, such as free checking.
I recommend Charles Schwab for checking: not only do you get free checking, you also earn interest and 100 percent ATM fee refunds.
Automatically invest 5 percent of each paycheck into your Roth IRA
Next you should set up a monthly automatic deduction for another retirement investing account: a Roth IRA.
A Roth IRA is better than a 401(k). With a Roth, you put already-taxed income into stocks, bonds, index funds — whatever — and you don’t pay when you withdraw it. Over 30 years, having a Roth IRA could literally mean doubling the money you would have made in a traditional retirement account.
I personally like Vanguard for this, because they have really low-cost funds. (If you don’t have a Roth yet, call them up, tell them you want to open one, and they’ll walk you through it.)
Automatically invest 5 percent of each paycheck into sub-savings accounts
After you put money into your investment account, you want to invest 5 percent of your paycheck into multiple sub-savings accounts.
Why have sub-savings accounts? There are always going to be unexpected expenses (stupid mistakes like late fees or penalties). Also, there are big things that you want to save for like a house, wedding or car.
You can accommodate these plans and surprises by proactively putting money aside for them every month. For example, I traveled last minute to Asia with my friends — just because — and I could cover the expenses with money saved in my sub-savings account. Not having to worry about stupid mistakes like parking tickets is a wonderful feeling.
I use Capital One 360 (no fees, no minimum, good interest rate). Start by saving $100/month in your sub-savings accounts.
Automatically pay all your bills with your credit card
Now, let’s talk about expenses. If any of your bills require you to log into an account and approve the monthly payment, switch over to doing it automatically and make sure you use a credit card instead of a debit card.
You want to do this for a few reasons. Number one: You save yourself time. Number two: You avoid the risk of forgetting and paying a late fee. Number three: You earn points on credit cards — I use Starwood Amex, which is great for that.
Automatically send checks to pay bills you can’t pay using a credit card
There are some bills that you might not be able to automatically pay with your credit card: rent, phone bill, cable/internet, etc. Fortunately, they are predictable expenses and banks allow you to set up automatic recurring check payments.
All you have to do is go to your checking account, set up bill pay and say, “On the 30th of the month, I want a check to be sent to the landlord in the amount of $850.”
The check will be delivered at the right time, and you don’t have to write checks ever again. Or have late fees.
Now, there’s one more thing here…
With the “set it and forget it” approach, you do all the right things automatically. This means that you have leftover money every month for whatever you want.
Instead of feeling like you can never buy stuff you want — or when you do, feeling guilty — you now get to spend extravagantly on the things you love. If you want to buy a $200 pair of jeans (if you can afford it) or take a $500 trip to Vegas for the weekend, do it!
That’s what I call living a rich life.
Ramit Sethi is a New York Times best-selling author and the CEO of GrowthLab.com, where entrepreneurs go to launch and grow their online businesses. On Tuesday mornings he binge watches “Vanderpump Rules.”