Couple have a coffee break during their road trip
Tanya Steinhofer No Comments

I recently saw James Clear, the best-selling author of Atomic Habits, speak at a conference. The premise of his talk and book is that by making small incremental improvements, we can make big changes in our lives. He offers a well-structured system for getting 1% better every day by improving our daily habits. It occurred to me that his system would work well for creating better financial habits as well. There are four steps to building a successful habit (or ending a bad one):

  1. Cue. The cue is a stimulus that triggers your brain to initiate a behavior. The two most common cues are time and location. The way to harness this step for habit formation is to make it obvious (or less obvious if trying to end a bad habit). To start a new habit, you can make a statement of what you will do at a certain time and location, by stacking a new habit onto an existing habit or by shaping your environment. As relates to finances, you could say “on January 1st each year, I will run my annual free credit report or rebalance my 401k” or “after using my credit card for a transaction, I will transfer money from the appropriate savings account into checking so money is available to pay the bill”. Another example would be if trying to reduce spending, you could reduce shopping cues by cancelling all catalogs that you receive in the mail and unsubscribing from retailer email lists.  
  2. Craving. A craving is the automatic desire triggered by a cue. In order to harness this phase to form good habits, the habit needs to be attractive. One way to do this is through something called temptation bundling, which is bundling an attractive activity with a less attractive, but important one. For example, if you really need to prepare your tax return or pay the bills, allow yourself to do something enjoyable, like drinking a glass of wine or watching your favorite show while doing them. Another trick is to reframe the hard habits to highlight their benefits. For example, instead of thinking of saving money as a sacrifice, you could focus on the increased freedom it will buy you in the future.
  3. Response. This step of habit formation is the response to the cue and craving. Repetition is more important in habit formation than how long you’ve been doing it. The way to increase habit frequency is to make it easy. Financial examples could include automating saving for various goals, with a payroll deduction for your 401k, and automatic monthly transfers to your kids’ 529s, or into other savings accounts for items such as emergency savings, a new car or a home down payment. 401k plans often have features that make saving for retirement easy. Many plans will auto-enroll employees with a certain percentage of their pay, allow you to set a date at which your contribution percentage will automatically increase and even automatically invest your money in the appropriate target retirement fund. All these features make creating good habits easier.
  4. Reward. This final step in habit formation is about reinforcing positive behaviors with positive results. The key to mastering this step is to make it satisfying. Ways to make it satisfying involve having an immediate reward after completing a good habit or by using a habit tracker to see your progress. Applying this to finances, you could allow yourself a small splurge every time you hit a large financial savings goal, such as maxing out your 401k for the year or paying off your car loan. You could use a calendar to track every day you skip buying the fancy coffee drink and deposit that amount into a savings account for a fun vacation or your next car.

With a bit of brainstorming and planning, we can design ways to increase our good habits and reduce bad habits. By getting 1% better every day, we can make big changes in our lives. Remember, “habits are the compound interest of self-improvement” – James Clear.