Table of Contents
- 1 Simple Things You Can Do Today to Improve Your Finances
- 1.1 How to Improve Your Finances – Top 5 Habits to Help You Get There
- 1.2 Conclusion on how to improve your finances
Simple Things You Can Do Today to Improve Your Finances
If you save a little money now, you are not going to be a millionaire by tomorrow morning. Not a chance! If you splurge now, you will not go broke today, quite possibly. But if you keep doing this over time, you’ll see some real changes. Changes that are either going to break you or make you financially independent down the road.
They are financial tips for 2022, 2023, and beyond, they’re really timeless.
Almost half of all New Year’s resolutions are about personal finances. Only 9% of all New Year’s resolutions succeed. This means that many promises that we make ourselves about both finances and other important topics in our lives such as health and relationships are broken.
That begs the question – Why is this so difficult? Why do people continue making promises to themselves that they cannot keep? And, perhaps most importantly, is there a way out of this infinite loop of disappointment? The answer to these questions lies within our habits.
These are the top 5 takeaways from the book Atomic Habits by James Clear. We’re looking at these habits from the view of how to improve your finances. But these habits can be applied to any area of your life where you desire to personally improve.
How to Improve Your Finances – Top 5 Habits to Help You Get There
1. The Aggregation of Marginal Gains
You’ve heard the exceptions, the overnight success stories. The entrepreneur who hit it big during their first year of business. The musician who won a contest and became an instant success. The person who guessed a correct string of numbers at the Powerball or lottery and won $176 million. These are stories of explosive wealth accumulation in a short period of time, and, while they can sometimes be mesmerizing, your chances of replicating them are almost impossible.
Let me ask you this: Do you know of something that you can and will do that is likely to improve your finances by 100% in a month? No? Well, if you have some huge investment money lying idle in your bank account and hire a proven investment adviser, it’s possible. But that won’t work for about 90 percent of people.
But do you know of something that could improve your finances by 1%? This is MUCH simpler.
It could be as straightforward as getting a credit card with some nice cashback, moving money from a cash account to an index fund, figuring out how to monetize your hobby, or just quitting that subscription service that didn’t add much to your life anyways. These are 3 simple things you can do today to improve your finances.
In Atomic Habits, James Clear points out that you need no defining moment to reach success, however you define success for yourself. Instead, you need many small wins that aggregate over time.
You need a ton of those tiny 1% gains, which are much easier to spot and act on, and over time, they’ll accumulate. If you can improve your finances by just a single percentage point each month, and you keep on doing that for the next thirty years, you’ll see some truly remarkable results.
James Clear refers to this as “the aggregation of marginal gains”. This is a really similar concept to what we know in financial circles as compound interest. And it works in the other way too. If you move 1% in the wrong direction for too long, you end up in a terrible spot.
This makes one thing strikingly obvious: It doesn’t matter much where you are right now. What matters is your trajectory. That’s because your current outcome is always a lagging measure of your habits. A small change in your financial habits will drastically affect your life when you allow it to compound.
2. Systems vs Goals
Conventional wisdom tells us to set smart goals. That’s S.M.A.R.T. Briefly, this stands for Specific, Measurable, Achievable, Relevant, and Time-bound. Here’s a financial illustration.
If we follow this advice on how to improve your finances, your SMART New Year’s resolution might look something like this: “By the end of this year, I will make sure that my savings account holds $20,000.”
It does sound like a good idea, but James Clear explains that even smart goals are actually dumb, especially for achieving long-term success and aggregation of marginal gains.
Here’s why. Goals are, per definition, only temporary changes.
$20,000 is quite a bit of money, but it’s not a match for a spendthrift to burn through. Goals are not very motivating. After you’ve reached your goal, you’ve won the game. As Warren Buffett likes to ask: “… and then what?” – Goals restrict your happiness.
In a sense, you are telling yourself that you aren’t satisfied until X happens. Happiness shouldn’t only be for your future self! Instead, we want to turn that financial goal on its head and ask the following: “What makes it so that I can have $20,000 in my savings account by the end of the year?” Take note of the process, the system, that will get you there.
If nothing pops up, try to imagine a person who can get there, imaginative or real. What does this person do on a daily basis? And – just as importantly – what does this person NOT do?
This person probably doesn’t wait until the end of the month to see if there’s some money left over to put towards investment, but rather, that’s the first thing they do when they get their paycheck or when the salary hits the checking account.
He probably doesn’t watch too many reality series, but instead, he consumes information that makes him wiser and that benefits him in the long run. Moreover, he doesn’t invest aimlessly, picking up the stocks of the latest fad that his colleagues at work recommend or that he heard about online.
Instead, he invests with a purpose and a strategy. Do you think that a person following these financial tips for young adults – with this system – can accumulate $20,000 by the end of the year? Of course, and he doesn’t even have to set it as a goal.
He will reach it anyways because he already knows how to play. According to Super Bowl winner Bill Walsh: “The score takes care of itself.”
The purpose of a goal is to win the game, but the purpose of a system is that you continue playing the game. To get as many reps as possible. Ultimately, it’s the reps in a properly constructed system that is driving success anyways. So now I think it’s time to learn how to keep playing.
3. The 4-Step Model of Habits
If you’ve ever wondered why you cannot stick to the habits that will improve your financial health or even transform you into the person you want to become, the answer lies in one of these four: Cue, Craving, Response, and Reward.
Biologically, we are wired so that when we are put in a certain context (cue), we want to feel something (craving), which gets us to act (response), and finally, get what we craved (reward).
For each rep, for each successful cycle in this loop, your habits become more and more internalized and easier to perform. The link between cue and reward becomes more obvious, which can be both an advantage and a disadvantage, depending on the value that you attach to a certain action.
Before getting into the loop, you need to take inventory. Create a “Habits Scorecard” where you write down what you do in a day with a + (positive), = (neutral), or – (negative) next to each habit, depending on if the habit is turning you into the person you want to be or not.
Now, you are ready to go.
The most powerful cues that exist are time and place. You want to make cues that lead to positive habits obvious and those that lead to negative behavior invisible.
For example, maybe you’ve noticed on your Habits Scorecard that if you’re at the bar with a certain group of friends right after receiving your paycheck, you tend to … show off a bit. You want to be “the king of the bar” on a Friday night after work.
Well, then you need to change things up. If you change the time or the place, you may have changed the cue so much that you will no longer indulge in this financially destructive behavior.
For positive habits, make it obvious, and there’s a powerful method for this which James Clear calls habit stacking.
While making that cup of coffee for yourself at home in the morning, you can learn about personal finance and investing by reading the Economist for example.
The next step is craving. You crave what is attractive to you, and avoid what is unattractive. Therefore, you need to make positive habits attractive and negative habits unattractive.
This can be done through as little as reframing your mindset about a few things.
For instance, when you see someone with an expensive car (which is not a good idea for your wallet right now), instead of thinking “wow, this person must be so successful because otherwise, he couldn’t have afforded that car”, you can think “wow, this person is probably pretty squeezed right now because he spent that much on a car.”
Such a mindset makes splurging less attractive. It could also mean that you pair some short-term reward with habits that otherwise just pay off in the long run. Warren Buffett has mastered this by making reading annual reports of stock market companies more attractive.
Thirdly, we have the response. You want the response to be easy for good habits and difficult for bad ones. James Clear gives a ton of great examples of how to do this in his book, and I think that the most powerful one to improve your financial health that we can talk about in conjunction with personal financial habits is the lock-out.
If you have a tendency to come home with more than you expected every time you visit the mall, then start bringing just enough cash for the purchase you planned, but no more. You can do similar things to lock in good behaviors.
Most people would rather dream about running a marathon than actually tying their running shoes. But you need to have confidence in the snowball that you are creating by starting out small.
Finally, there’s the reward., Positive habits should have satisfactory rewards while negative habits should have unsatisfactory ones.
A surprisingly satisfactory tool to use is the streak. It also works in the opposite direction; I truly hate breaking my streaks. The keyword here is visuals. Put up an almanac on your fridge and make a clear green checkmark on every day that you, for instance, did not end up with your hand in the cookie jar, ie. taking money out of your investment account for personal consumption.
If you did, make a big red cross. But do not miss twice.
If you can get these four right, you are MUCH more likely to stick with the financial habits you wish to have and avoid those you do not want.
And there’s something that might be even more powerful that you can do …
4: Rooting Your Habits in the Deepest Layers
There are three layers of change: Outcomes, processes, and identity.
We’ve concluded that processes, or systems, are more powerful than outcomes, or goals, but the most powerful habits have their roots in the deepest of the layers: identity.
Here’s an example. Which of these statements is more powerful? “I’m trying to quit smoking” and “I’m not a smoker.” Which one do you think is more powerful?
Another one: “I want to save $20,000.” “I am an investor.”
It’s one thing to say that you want this, and a whole other story to say that you are the person who is this. People hate contradicting themselves to such a degree that sometimes they can become completely blind even to facts, just to stick with a certain identity or belief that they’ve built up over the years.
Therefore, you want to choose your identity and beliefs carefully. Habits and identity are a two-way street.
Imagine that you have jars of multiple characteristics inside of yourself, some of them even contradicting. Every time you choose a certain action, you are casting a vote for one of these characteristics. This makes some future actions more likely and other actions less likely. Therefore, we cannot talk about these things in a vacuum. Habits and identity live in a constantly reciprocal relationship.
Suppose you wish to strengthen your identity in a certain area. In that case, one of the most powerful things you can do is to join a community where many people share the beliefs you are aiming for.
5: 80% Exploit, 20% Explore.
Machiavelli said that:
“Men desire novelty to such an extent that those who are doing well wish for a change as much as those who are doing badly.”
Habits have a certain weakness. They lock you in on a given path.
If you are not satisfied with where you are right now with your finances, chances are that you need to push a little bit to change things up. Meanwhile, if you are content with where you are, you needn’t change much – repeat what works!
However, as Machiavelli says, even people on an obviously successful path will eventually reach an obstacle – boredom. Boredom is the enemy of habits that move you in the right direction. Sooner or later, these habits will lose their shine, just like that shirt you used to love, now hanging in the back of your wardrobe.
It’s still a nice shirt but … you need novelty.
James Clear suggests that there must be a balance here. If you are going where you want to exploit, or repeat what works, 80% of the time but do not forget to explore the remaining 20%. This is a great way of stopping yourself from fiddling with the 80%! For an investor, it could look something like this.
Maybe you’ve been a successful index investor for a while, but you’re getting bored from just automatically transferring a certain portion of your salary into the same old index funds every month. Then take 20% of your capital and try some individual stock picking. This doesn’t just combat boredom. It’s also a chance for improvement.
Conclusion on how to improve your finances
Here are our concluding remarks on how to improve your finances in one year, over the next 5 or 10 years, or whatever time frame you set for yourself.
- Stack a ton of 1% improvements on top of each other, and you’ll see remarkable results over time.
- The score takes care of itself when you have a proper system in place.
- If you are having trouble sticking to a certain habit or a system of habits, the answer lies somewhere in the cue, craving, response, and reward loop.
- Making behaviors a part of your identity is to root them in the deepest of layers.
- Repeat what works 80% of the time and renew yourself the remaining 20%
Got any questions, suggestions, or other money management tips for beginners or those struggling to save money, share them in the comments section.