Your Paycheck Is Leaking: The 3-Step ‘Pay Yourself First’ System.

Why does your salary keep disappearing from the first payday?

‍
Buy groceries, pay off debts, pay for a subscription to a gym, and earnings are melting before our eyes. Most people know that saving money is important. We read articles, looked at charts, and even downloaded budgeting apps. But when theory meets real life, the result is the same: intentions disappear, and the human factor takes over. "Most employees do not have the financial knowledge to determine how much to save and how to allocate investments - a classic example of bounded rationality." (Thaler & Benartzi, 2004). People do not save money, not out of indifference, but because they do not know how to correctly determine the necessary amount of savings to provide for themselves in old age.

This is not only a financial problem, but also a psychological one. In a groundbreaking 2004 study, "Save More Tomorrow: Using Behavioral Economics to Boost Employee Savings," economists Richard Thaler and Shlomo Benartzi found that the reason people have difficulty saving is in their heads. “Many employees who save too little do not make rational decisions, but make a psychological mistake, and would be happy to help them make more effective decisions.” - Taler and Benartzi speak (2004). Their research not only explained why people struggle to save but also created a simple and practical solution that revolutionized financial planning worldwide. The SMarT - Save More Tomorrow program. The best thing is that you can start putting it into practice now. First, learn more about the study itself.

Bounded Rationality

‍
The psychology of a leaky salary Thaler and Benartzi began with a simple observation: when companies switched from fixed retirement plans to self-managed savings plans (such as 401(k)s), employees suddenly became responsible for their own financial future - and most of them failed. Behavioral economics helps us understand why. Researchers have found that no matter how rational a person tries to be, there is still more human in him, and it takes over logic. Here they are: Bounded rationality - people can hardly calculate how much they should save. Lack of self-control - we prefer the pleasure of spending now to the reward of saving later. Procrastination - We intend to save money “next month,” but this month never comes. Loss aversion - any visual reduction in current income feels painful. Taken together, these factors lead to what Thaler and Benartzi called a “systematic error in saving.” In a nutshell, money doesn't just go out of your salary - it goes out because of human psychology.

SMarT Program in Action

‍
Instead of fighting against human nature, Thaler and Benartzi have developed a tool that harmonizes with it. Their idea: “People commit themselves in advance to direct part of their future salary increase to retirement savings.” - Thaler and Benartzi (2004, p. 164). The "Save More Tomorrow" (SMarT) plan was born, which turned procrastination, loss aversion, and inertia into allies.

How it worked: Employees today have committed to saving money later. Their savings level automatically increased with each salary increase, which mitigated the feeling of loss. After registration, the plan continued automatically, unless the employee refused to participate. The results were as follows: during the first testing in the company, 80% of employees joined the program, and 78% stayed after receiving at least four promotions in the first year. The average level of their savings has increased fourfold from 3.5% to 13.6% in 40 months. In later trials at Ispat Inland and Philips Electronics, even minimal intervention in the form of a single letter resulted in increased savings. Behavioral design succeeded where financial education has failed.

Visual graph, among the US population:

From theory to practice.

‍
We are adapting the three-step "Pay yourself first" system. That's a familiar expression, isn't it? It was first popularized by George Samuel Clayson in his debut book, The Richest Man in Babylon. Advice from the author: Read this book.

Inspired by the ideas of Thaler and Benartzi and the expression of Claison, let's apply the same principles of behavior to our own finances.

Step 1: Pay more today doesn't sound nearly as appealing as "Save more tomorrow." There is never a good time to save money. Decide now which part of your next raise or bonus you will put aside.

Step 2: Automate decision-making on savings or investments. As Thaler noted, “Default options are effective because they eliminate the need for willpower.”

Step 3: Gradually increase your savings rate: Every time your income increases, increase your savings rate by at least a minimum of 1-3%. Small, painless steps lead to significant results over time. Loss aversion - people experience the pain of losing money more than the pleasure of receiving the same amount. This means that any reduction in wages, even if it is aimed at saving, is perceived as a personal loss, so we instinctively avoid it. There is no need to “manage money better". You just need to create a system that does all the hard work for you.

Key Takeaways.

‍
Saving does not depend on willpower, but is determined by the structure of our environment. The study by Thaler and Benartzi proved that people's financial choices are not always logical, but they follow certain psychological patterns. Procrastination, bounded rationality, and loss aversion can hinder accumulation, but if the system is properly organized, these features can become our allies.

The Save More Tomorrow experiment showed that automation and a gradual increase in savings are more effective than motivation and self-control. Linking savings to future salary increases reduces the feeling of loss, and the "default correct" approach uses inertia to achieve financial stability.

The idea of "Pay Yourself First" is a modern take on this concept. It lies in the fact that by putting savings first, even before you start spending, you are not trying to fight your weaknesses, but instead create an environment where the right choice becomes obvious and natural. Your income will stop leaking when you become the first person you pay.

‍