Turning the Monthly Mentality to Your Advantage

Money & Happiness

Turning the Monthly Mentality to Your Advantage

by Laura Rowley

Friday, June 30, 2006

Last week I wrote about the monthly mentality -- the mind-set in which people make major purchases based solely upon their ability to swing the monthly payment (see "How the Monthly Mentality Messes Up Your Wealth"). Whether it's taking out an interest-only mortgage to stretch into a bigger home, a 72-month auto loan to afford a luxury car that's otherwise out of reach, or a credit card to get the giant flat-screen TV of your dreams, the monthly mentality can destroy long-term wealth.

Now for the flip side: Apply the monthly mentality to savings and paying off debt, and watch your financial health flourish.

Consider reader Lisa Miller, who increased her retirement savings tenfold over five years by applying the monthly mentality in reverse. "It's much easier for me to tolerate a few hundred dollars (or even just twenty dollars) in monthly investments than it would be to tolerate a few thousand dollars in annual contributions," she wrote in an e-mail. "Although the monthly mentality can be extremely dangerous in the context of spending and loans, I think that the same mentality can also build phenomenal wealth."

Bringing Your Goals Within Reach The monthly saving mentality works because it breaks an intimidating goal -- like socking away a massive retirement or college fund -- into bite-size chunks. It's also ideal for debt pay-down, especially for people who make the minimum monthly payment on their credit cards.

Let's say you have a $2,000 balance on a card at 16 percent, and you pay a minimum of $80 a month. At that pace, it will take six years and nine months to pay off, with $808.23 in interest. Toss in an extra $20 a month, and you'll pay off the debt in just two years -- and pay only $305.63 in interest. To figure out what an extra $20 a month would do to your debt repayment, see the credit calculator at Yahoo! Finance.

Once you wipe out your credit-card debt, maximize the monthly saving mentality by redirecting that $100 payment toward a rainy-day fund. Fewer than 4 in 10 Americans have an emergency savings account equal to three months' living expenses, according to a recent survey by . Those who do often leave money on the table: 30 percent of such accounts are earning less than 3 percent on their savings, and 7 percent earn no interest at all.

While the average money-market account is yielding a paltry 0.79 percent, some highyield money-market accounts are close to 5 percent. Online banks -- such as and , which can be linked to your checking account -- offer interest rates of around 4.7 percent, with no minimum deposits and no fees (see for the best savings rates).

The monthly mentality can work wonders for mortgages as well. Take your monthly mortgage payment, divide it by 12, and throw that extra amount in every month earmarked for principal payment.

For example, consider a $250,000, 30-year, fixed-rate mortgage at 6.5 percent. The monthly payment would be $1,580.17. Throw in an extra $131.68 a month -- which adds up to one extra mortgage payment a year -- and you'll shave almost six years off the mortgage and save nearly $73,000 in interest. (To figure out how much you'd save by making an extra payment, see the amortization calculator on or on Yahoo! Finance.)

The Treadmill to Disaster I know some readers will suggest that it's smarter to take an extra mortgage payment and invest it in stocks. But it's likely the money will never be invested because it's so effortless to slip into the monthly spending mentality instead. One culprit is the "hedonic treadmill" -- the phenomenon in which we adapt to an improvement in our circumstances, and then seek to trade up to bigger and better.

Professor Richard Easterlin of the University of Southern California has examined this phenomenon in depth. In one case, he analyzed the results of a Roper Starch survey that asked adults about their material aspirations and achievements. Roper asked respondents the following: "We often hear people talk about what they want out of life. Here are a number of different things. When you think of the good life -- the life you'd like to have -- which of the things on this list, if any, are part of that good life as far as you personally are concerned?"

The list included such items as a home, swimming pool, vacation home, cars, and travel abroad. The respondents were then asked to go down the list and name all of the things they currently owned.

The survey was conducted twice, once in 1978 and again in 1994. Because the two surveys were conducted 16 years apart, Easterlin was able to analyze whether people's aspirations shift as they age and their circumstances change. Not surprisingly, he found that as consumers age, they typically acquire more of the goods on the "good life" list.

But as they accumulated more, he found that their aspirations for material goods also rose -- and in proportion to the amount of things they owned. In other words, he found scientific proof of the old adage that says "the more you have, the more you want."

Combine this with the fact that it's a whole lot easier (and more fun) to slap the plastic down on the Best Buy counter than it is to enroll in a 401(k) plan, and you can see why people gravitate to the spending side of the monthly mentality.

Pushing the Envelope

To get into the monthly saving mentality, first identify the black holes in your budget. I recently started using an online budgeting program called Mvelopes Personal to better track my family's expenses in real time. (Mvelopes offers a 30-day free trial; a monthly subscription costs $8 to $13.)

In our grandparents' day, people budgeted by putting cash in paper envelopes -- one for food, one for clothing, and so on -- and stopped spending when the money was gone. Mvelopes mimics this system, allowing you to budget for each spending category in virtual envelopes. You link the program electronically to your checking, savings, debit, and credit cards, so it automatically records purchases in a "New Transactions" folder.

Just log in, then click and drag a recorded purchase into the appropriate envelope; if you buy multiple items at one store, click "split" and divide the receipt into the right envelopes. (Cash purchases have to be entered manually.) Mvelopes deducts that amount from the envelope, so you can easily see, for instance, that you've already spent $85 of the $100 budgeted for clothing.

Before I tried the software, I tracked every penny we spent for 90 days with paper and pencil. Otherwise it would have been tough to know exactly what categories to budget and how much to put in each envelope. The payoff? Mvelopes quickly revealed a few of our black holes, such as clothing, dry cleaning, and baby-sitting.

Once you've identified your own budget-busters, you may be able to spend more carefully in those areas, free up cash -- and make the most of the monthly saving mentality.

See Laura's answer to the question "What's the trick to living in the moment?" at Yahoo! Answers.

The columns, articles, message board posts and any other features provided on Yahoo! Finance are provided for personal finance and investment information and are not to be construed as investment advice. Under no circumstances does the information in this content represent a recommendation to buy, sell or hold any security. The views and opinions expressed in an article or column are the author's own and not necessarily those of Yahoo! and there is no implied endorsement by Yahoo! of any advice or trading strategy.

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