Personal finances is a complex topic. You might even say a complex system (click that link to understand why our efforts in fixing these sorts of problems often fail.) What research has been done on complex systems? How can we make them better? This post is about how to fix our personal finances. Well, it’s an experiment to see if the research helps.
Like many of you, I’ve always spent what I make. If I have $10, I’ll spend it. If I have $1,000 I’ll spend it. I spend all the monies! I can think of at least two reasons why this is the case for me. The first reason is that I grew up poor where I always envied my classmates packed lunches and new clothes. The second reason is that we humans don’t do delayed gratification well. You might even say we utterly suck at it. These reasons aside, the fact remains I’ve always spent what I’ve made. What can I do about it?
The Theory of Constraints
A co-worker (who is blessed by the high heavens) mentioned a concept in manufacturing called, “The Theory of Constraints.” Now this theory isn’t traditionally applied to personal finances but that’s where things get interesting. When we take two or more ideas from different perspectives and put them together magical things happen.
A good summary of the theory is:
A chain is only as strong as it’s weakest link.
It’s to say, any complex system is only as good as the weakest link or the bottleneck. These are called constraints. In any complex system there is at least one of these constraints but probably not more than three. It’s important that the number of these constraints be very small or only one.
The theory goes on to suggest that once you’ve identified the bottleneck you then proceed to exploit the constraint with a solution; make the exploitation of higher priority than every other part of the system; and finally seek to remove the constraint altogether.
- Identify the weakest link.
- Exploit the problem (aka. find a solution to the weakness.)
- Make everything else less important than steps 1 & 2.
- Remove the constraint completely.
If we’re talking personal finances, this outcome sounds pretty great! No more financial troubles? Sign me up.
Identifying the weakest link for me
At the beginning of this post, I mentioned that I’ve always spent what I had. This was a quick way to let you know that my weakest link is: spending money. It could be random outings, toys, or just eating out. My money always seems to disappear.
Now, it’s important to understand (and this is simplified) that I have had a written budget for many years and I have three basic accounts within my bank. I can transfer money between these accounts instantly. The accounts are as follows:
- Billing Account (checking / debit) — bills and expected expenses are paid from here. Direct deposit goes there.
- Cash Account (checking / debit) — day-to-day expenses come from here, gas, groceries, parking fees, etc.
- Savings Account (savings) — money deposited from my billing account
I got to thinking about it (exploiting) and I realized that if I see $100 in my spending account then my brain thinks I have $100 and I spend like a person who today, right now, has $100. This is in fact not correct or true. I don’t have $100 (well I do but…) I have $100 for a period of time.
This makes for a vicious cycle. If I put $100 into my cash account and spend like I have $100 then I’ll be out of money fast. It’s happened so many times that I’ve lost track. If I run out of cash then what happens when I need groceries or gas? Things that I actually need? Well, this is where savings and bills takes a hit. Then I’m stuck trying to play catch up. As I mentioned, it’s a vicious cycle.
The problem is that my mind cannot keep a running tally of money over time. Dollars spent, will spend, and running balances it’s all just too hard to put in my head. I can only understand today’s money and therein lies the problem and the solution. What if I could handle my money in such a way that I only ever had today’s money? That would be cool but how would that work? Here’s what we know so far: we know the weakest link, I have in mind how much I want to spend on day-to-day expenses.
So, let’s get to the experiment!
The 16-day Experiment
Here’s how the experiment is going to work:
- Remove all money from spending account on day 1.
- Start with a base amount of spending money. Let’s say $500 dollars which comes from the billing account.
- Divide that amount by the number of days it needs to last. Let’s say 16 days. The amount is $31.25 but let’s round down to something easier to remember: $30/day. That’s easy enough.
- Each day deposit my daily allowance of $30. This has a few benefits: 1) I’m aware of how much money is in my spending account for today. 2) I can spend this money without any guilt since it doesn’t have any future money in it. 3) I can play the game of trying to beat my daily spending allowance. Now it’s becoming fun!
- Do this for 16 days and track how it’s going. I’m particularly interested in the ways I don’t spend money and how resourceful I become.
Pretty simple, right? I mean it’s easy to transfer money because it’s instant. It’s an easy number to remember. Maybe you have questions so let’s address those. So let’s say it’s day one of the experiment and I need gas but I only have $30 and I need to eat. Well, why not buy only $10 of gas? The point is almost anything can be suffered for a day. Whether it’s eating out, or going out with friends, or making a purchase, nearly everything in our lives we can live without for a day or two.
Drum, buffer, and rope
Within the Theory of Constraints is the idea of drum, buffer, and rope. The drum is the drum beat of the bottleneck, it sets the pace for the whole system. The rope is what holds the various parts of the system together. Think of a teams of runners competing against each other but you’re judged by the time the slowest person crosses the finish line. If you tie the runners together with rope then they will finish the race faster than they would apart. The buffer is having a little extra so that if there are any problems you can resolve them. For me, this is my savings account, it acts as an emergency fund.
The most important thing to have here is the rope. It’s the thing that slows everything down so that the whole system can move together effectively. That rope in the daily deposit of $30. It effectively acts as brake on spending. If forces me to either do without or save some money for the next day. The key is that it slows the whole system down. In this model, I’ll have to wait for purchases. That is a very good thing.
Excited! But we’ll see…
I’ve talked this over with a number of friends. You know you’re on to something when they all independently say, I think that could really work maybe I’ll try something like that. So, I’m pumped about trying it out but I’ve tried things before which is why this is an experiment.
Each day I’m going to deposit my daily allowance and try to not spend it. I’ll try to make the balance rise each day. I’ll keep a journal of what kind of decisions it forces me to make. At the end, I’ll summarize it all and make guesses on how this would play out over a longer period of time. I may have cracked the nut on overspending and that has me jazzed.
One enthralling facet: before this exercise I paid little attention to my cash account other than ensuring it was flush at all times but now I’m seeing that it’s the most important and dangerous aspect of my budget. I believe this one change is going to impact the whole of my finances.
Also, this is not a post about me wanting you to solve my problems or come up with a different theory. I’m genuinely interested in finding what works for me. I like thinking through problems on my own and experimenting to see if they work. I find the Theory of Constraints compelling so I’m going to spin the wheels. Whose with me?
See you on day 16!