Friction: A Tool for Managing your Finances
You're at the checkout and you see that pack of gum. Do you buy it?
Retailers are masters at minimizing friction to encourage you to make purchases. When it comes to managing your finances, you can use this concept in reverse. You want to make it harder to spend money or make decisions that run counter to your goals. Or at least create enough friction that you pause and think before making the purchase.
A great example is using cash for purchases. Back in the day, when credit and debit cards weren’t a thing, you had to carry around cash in your wallet. If you wanted to make a purchase you had to pull out the cash (at the same time noticing how much money you had in your wallet) and decide to continue with the purchase. Banks realized that if they removed that bit of friction (actually seeing in physical form how much money you had), you would be more likely to spend.
So if you’re wanting to be more intentional with your spending, then how can you create your own friction in your finances? One way is to go back to using cash. The cash envelope system is a great method if you struggle with keeping on a budget. Another method, and the main point of this article, is to use different bank accounts for different types of spending. This is a great alternative to the cash envelope system if you prefer keeping everything digital.
The most common types of spending can be broken down in the following way:
Bills (things you need)
Rent, utilities, insurance, etc.
Debts
Mortgage, vehicle loans, credit card payments, etc.
Recurring fixed expenses (things you want to have that don’t change price )
Gym membership, streaming, house cleaner, etc.
Day to day expenses (miscellaneous spending)
Groceries, restaurants, clothing, etc.
Larger, less frequent purchases
Skis, bikes, expensive articles of clothing, etc.
Travel/Trips/Entertainment
Instead of managing how much money you can spend on every single item (i.e. a grocery budget, an eating out budget, etc.). You can use larger categories to more easily manage your spending and create friction between the have-to-haves, and the want-to-haves.
Bills, debts, and recurring fixed expenses are generally a necessity. There may be some recurring fixed expenses that can be adjusted but if you decide you want a thing on a recurring basis it is pretty well fixed. All of those expenses should come from a dedicated Fixed Spending (Bill Pay) account. This is the easiest account because all of the expenses are known and the day the expense is due (or close to it) is also known. This account can easily be planned out.
The second category of day to day expenses (miscellaneous spending) is usually where people get into the most trouble. By separating these types of expenses out into their own account, you can easily manage how much money you spend on these types of things.
This is where the friction comes in. You pre-determine an amount for miscellaneous spending money that should get you through the month. You have more money than the amount inside this spending account, that amount is just what you’ve determined is reasonable, and will keep you on track with your financial goals. If one month, you use it all, but still want to spend more, you have to make a choice.
Where does the extra money come from?
You probably can’t take it from your fixed expenses because those aren’t changing. What’s left is generally your savings. Do you want to pull from your savings to buy that pack of gum (or whatever it is)? That is a choice you have to make. That is the friction.
Creating a financial system that automatically puts limits on your miscellaneous spending forces you to consciously make the choice to move beyond the bounds you initially set up. There are no right and wrong answers, you have to decide for yourself at that moment how you want to handle it. The point is to create that friction so you spend your money intentionally instead of unintentionally. To create a moment where you have to stop and make a decision: is this really what you want to do? If so, great. If not, then the friction helped keep you on track.
The third category is for larger, less frequent expenses. These fall into two smaller categories: the expected/planned for, and the unexpected. In particular, large unexpected expenses have the tendency of throwing off your entire financial plan because if it’s unexpected you don’t have funds set aside for it, and you have to take the money from somewhere else.
Here’s the thing, we’ve all gone in to get our oil changed, and left with an unexpected $500 bill. Or needed to take an emergency visit to a loved one. While you might not know exactly what is going to come up, the simple fact is that something will come up. That’s life, so why not make a plan for it?
This is where we get creative with your savings account(s). When all of your savings are in a single account, it is easy to pull from it for whatever expense has just come up. When you break it up into different accounts that have names like “Emergency Fund” and “Hawaii Trip” or “House Down Payment” you know that all of that money is already allocated towards something else. Is this new pair of skis really an “emergency”? Does it trump your goal of buying a home?
There’s that friction again. By having your money specifically assigned to certain objectives, it becomes harder to steal it for something else. This helps keep you on track towards your goals and makes it much easier to plan.
Now, you might be wondering how you are going to manage all of these different accounts. Automatic bank transfers can do most of the legwork for you. Set it and forget it. And then transfer the money from a savings account to a spending account when you need to use it for the specific objective.
There are also some banks that allow you to create buckets or sub-accounts to organize your money in this way. If you don’t need a lot of friction to keep yourself inline these can work great since they’re basically doing the same thing as separate accounts. If you’re someone who needs more friction though, put the money in a totally different bank so you don’t even see it. Then you’re even less likely to interfere.
Ultimately it is up to you on how much friction you think you need and far away you need to separate your money. There is no single right answer because every person’s personal habits, and goals are totally different. That is why finance is so personal. You have to find the method that will work best for you.
