The Psychology of Passive Investing

Personal finance bloggers and personal finance connoisseurs (such as me) often feel that they have ultimate control over their actions. The belief is that if one is aware of his goals, he can reach them with the greatest of ease.

  • Do you want to create an emergency fund?  Easy.  Spend four months building one.
  • Do you want to retire at age forty? Not a problem.  Control spending now and begin investing in tax-sheltered investment vehicles.
  • Do you want to reduce your money spent on gas? Simple.  Hypermile!

Bad Decisions

For the most part, people who frequent personal finance sites have better control than the general public, but they also harbor a dangerous attitude. Many posts about the savings rate of America (barely scraping above 0.0% now) curry responses decrying the lack of self-control of the general public. I know that I have fallen victim to my own  questionable personal finance decisions before… Is it because I was completely unaware? No.  Is it because I didn’t care about the impact? No.

The bad decisions I made were usually because I did not understand the gravity of the decisions I was making at the time.  For example, my decision to attend an expensive private university (even though I currently have no regrets) may have been different if I had considered all the angles.

Nudges and Shoves

Picture of 0 bills.

Turning off your mind when investing may be the easiest route

The Save More Tomorrow program is an economic, behavioral and psychological prescription for controlling spending / saving habits. The program is simple… The participant does not save any more money today, but promises ahead of time to devote a certain portion of future pay raises to savings. In this way, once an employee gets used to a certain amount of spending, they can save more simply with future raises. In a few studies, this has shown to increase the savings rate of participants from 3.5% to 11.6%. Does this imply that those who wish to save (such as these participants) are simply willing but unable? What does this mean to those who believe that they have a good handle on their finances?

The ‘Magic’ Of Automatic Savings

Perhaps the best way to continue one’s path to financial independence or early retirement is to set up automatic contributions or investments. Devoting a portion of one’s paycheck (outside of an employer-sponsored 401k) to a dedicated saving/investing account can be the best way to turn off the mind and just get money into investments. The amount of the automatic investment is not what is important: any investment will simply “reduce” the amount of money you have to spend, skimp or save. This method also has the added benefit (debatable…) of dollar cost averaging into investments, reducing one’s exposure to quick fluctuations in asset prices by spreading out purchases over time.

Does anyone have any experience trying to dedicate a portion of their paycheck (outside the 401k) directly to savings? Is there any other personal finance decision that you have made that could be improved upon (despite believing that you are in complete control of your actions)? How much do you love/hate cognitive dissonance?


Cameron Daniels


  1. says

    The automatic savings route has worked incredibly well for me throughout my work career, even at the point when we were making less than $750, paying over $300 in taxes/health insurance, we saved $100 a month (we were living in Zimbabwe in the early 90s and our housing/utilities were paid for us).

    Right now I deduct straight from my paycheck to the 401K, but also to the HSA I have.  Again, if I don’t see it, it doesn’t seem to hurt as much or be as difficult to do.

  2. says

    That’s an interesting trend. My wife and I are now able to save more than we were able to this time last year because she took got a promotion (and I am making a little on the side). 

  3. says

    For years I have had my Roth IRA and kids 529 investment amounts withdrawn automatically from my checking account on a specific day each month.  So, yes, we take advantage of dollar cost averaging.  It is a bit of a hassle to cancel or change the investment, so we leave it, which forces us to automatically save outside of 401k each month.  I highly suggest this method, as it is a way of forcing diligence in long term investing.

  4. The Buy and Hold Guys says

    I liked your post.  Another way to “automate” your net worth (in addition to your 401K and regular savings) is to buy rental property.  Weather you choose a 15 year loan (if you’re more conservative) or a 30 year loan, each mortgage payment builds equity and wealth.  

    If you take the time to educate yourself, you can find a market where the property will cash flow $200-400 (with a property mrg).  Just my opinion, the combination of principal pay down, yearly cash flow and tax treatments makes rentals the preferred vehicle for wealth accumulation.

    I’m not saying only invest in property, but there’s no reason each household shouldn’t add 2-3 rentals to their portfolio. 



    • CameronDaniels says

      100% agree, but I would consider rental property as just a portion of an overall asset strategy. If you have $0 in a 401k, $0 in savings/emergency fund, $0 in an IRA and $0 in bonds, I would not suggest buying a rental property (or even a primary home).

      The key is to look at how much equity you have exposed to the housing market. If your primary home put down $30,000 and now has $50,000 in equity and you are able to parlay $20,000 extra into rental property? Even with the positive cash flow (consider it like dividends on a bond/REIT), you may be exposing yourself to more risk than initially thought!

  5. says

    Hey Cameron – very good post.  I do have automatic retirement contributions withheld and I also have a small amount that goes directly into an aftertax savings account.  That’s been the most helpful way for me to save because it’s automatic.  When I try to actively save my disposable income, it’s usually doesn’t add up to the amount of what’s withheld automatically.  Why? Probably because I forget that it’s being withheld and the disposable income I try to save always seems to find some place to be spent.

    • CameronDaniels says

      It must be something about human psychology: you earn a certain amount of money, and you are forced to spend up to that amount. By investing automatically you never really see it as “earned” so you don’t need to spend up to that amount.

      I have heard a very good analogy that people have used to explain the obesity issue in America today. We are taught from a very young age to never leave anything on the plate and be thankful for what we have (which could be interpreted as being modest, but often is taken the other way). This makes us “eat everything on our plate” establishing, from very early in life, a habit of not leaving anything out of consumption.

      “Food” for thought (pun intended).

  6. says

    I really wonder how possible it is on a fairly average wage to save enough to retire on. If for example you manage to save $100 per week, that would equate to $5200 over a year. After 10 years this will be $52,000 A decent amount of cash, but not enough to retire on, even if you’ve managed to double it with good investing. IMHO if you want to retire early, then you should really focus on MAKING loads of cash, rather than saving it. Obviously you have to have some control over your spending whatever you earn, but I think too many people focus too much on saving small amounts of cash, and miss all the opportunities to make big cash that are all around them.

    • CameronDaniels says

      A couple caveats: I believe somebody on a fairly average wage can put away much much more than $100/week. I know some people on relatively meager wages who can put away near $2,000 a month.

      As you said, $52,000 with good investing may be double, but the key is that is only ten years. If you then look at it as 30 years, that initial $52,000 will be $400,000, the next 10 years will be $200,000, the next 10 years will be $100,000 all for a total of $700,000. This may not be enough to retire on, but this is assuming you are not buying a house (and paying down a mortgage) and your wage is staying exactly the same for 30 years (which is quite possible).

      I do agree with your general sentiment though that it is difficult to earn enough to put away for one’s own retirement. The difficulty in crossing the initial hurdle may be what is causing many in America to have a negative savings rate.