Earn More Interest by Reducing Savings Friction

By Emily Guy Birken on 28 November 2016 0 comments

Friction is the small resistance that stands between you and a transaction. Think of the way your favorite e-tailers remember your credit card information, saving you the hassle of having to get up, find your wallet, and type in your information. Those e-tailers are reducing the friction of your purchase, making it that much more likely for you to buy.

Transaction Costs

We've talked before about how friction is another term for mental transaction costs. These are the nonfinancial costs associated with making a purchase or transferring money to a savings account. There are several types of transaction costs that increase friction, but the two that are most likely to affect your ability to save money and control your spending are time costs, and search and information costs.

Time Costs

Any time you have abandoned a purchase in the store because the checkout line was too long and you were unwilling to wait for the slow-as-molasses staff to help you, then you have felt the impact of time costs. Time costs can keep you from saving money because you are unwilling to put in the time to manually transfer the funds.

Search and Information Costs

Search and information costsare the work you do to figure out the best course of action for your money. If you have to think about what kind of savings product to use or how much money to transfer to savings, then you are less likely to actually save the money.

Friction can help or hurt your bottom line, depending on what type of transaction is affected by it. In general, you want to reduce the friction you feel when you save money, and increase the friction you feel when you spend it. Read on to find ways to use friction to your advantage to increase your savings and reduce your spending.

1. Automate Your Savings

The ultimate way to reduce friction when you save money is to make it automatic. Setting up an automatic transfer from your paycheck into your savings account means that you don't have to think about putting the money aside, find the time to set up the transfer, or agonize about the amount to save. It's a seamless transfer of your money to savings.

2. Move Your Savings Account to Another Bank

For some savers, putting money aside is no problem. The issue is that it's far too easy to access that money. Increase the friction involved in accessing the money in your savings account by opening an account with another bank — preferably one with no branches near you. Generally, it will take a couple of days for a fund transfer between banks, whereas a transfer within a bank is instantaneous. The time cost of waiting for your savings to transfer from the inconveniently located bank to your checking account will be enough friction to keep you from raiding your savings.

3. Have Your Paycheck Deposited Into Your Savings Account

Many prolific savers put their pay directly into their savings account and then transfer the amount they need for monthly bills into checking. This harnesses both the reduction in savings friction, and the increase in spending friction. Since the money is already deposited into your savings account, there is no friction on that portion of the transaction. Placing the friction on the transfer-to-checking side of the equation allows you to keep more money in savings and lessen the chances that you will spend your money mindlessly.

4. Use an Automatic Savings App to Round Up Your Purchases

Starting with Bank of America's Keep the Change program, which launched back in 2005, technology has been working hard to remove the friction from your savings habit by making it automatic. There are now a slew of different automatic savings apps that do everything from rounding up your purchases and placing the excess into savings (Bank of America's Keep the Change and Acorns), to analyzing your cash flow to determine an amount that's safe to transfer to savings (Digit), to letting you know the amount of money that is still safe to spend in your account (Pennies and Level).

5. Bill Yourself for Savings

If you already have a solid bill-paying routine in place, add one more obligation to your list: yourself. Making "savings" a bill can actually reduce your savings friction because you will complete the action while you are already paying all your other bills. Set up a bill reminder to transfer money to savings on the same day you pay your other regular bills. It will be surprisingly easy to pay yourself if you treat it like a bill.

6. Continue Making Payments on Your Paid Off Loans

Once you have finally sent your lender the last payment for your car loan, your student loan, or your credit card balance, it may be tempting to just enjoy the extra money each month. But a savvier plan would be to continue paying that amount to yourself. As you come to the end of your loan, set up an automatic transfer of the payment amount into your savings account on the same day of the month you paid your loan. That will reduce the friction of saving the amount, because you will not even notice a difference in your monthly spending.

Harnessing Friction for the Win

It is truly amazing how unmotivated we all can be in the face of transaction friction. Increasing your savings and reducing your spending is just a matter of strategically tweaking the friction you will feel when you save or spend money.

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