Read an Excerpt

Chapter One

Debt Laughing all the way to the Darwinian bank

Why do we have such a hard time saving money? Take the following quiz: First, how much money would you like to save each month? Write down your answer as a percentage of your income. Second, how much money are you saving? Look at the last few months of your actual savings behavior, not your dreams about next year after you pay off your credit card debt. Write down your actual savings as a percentage of income. Now compare the two figures. The unpleasant reality is that most of us save far less than we want to.

Average Americans want to save 10% of their income and claim to save about 3%. If only that were true. We set a record low in February 2000, with a 0.8% savings rate. In other words, if you took home $2,000 after taxes and you saved like an average American, you spent every cent except a measly sixteen bucks.

The result is that Americans have little or no cash to spare. Enticed to spend by urgings everywhere we turn — from the Internet to billboards to crafty product placements on TV and in movies — we are a nation of spenders, rushing to deposit paychecks into minuscule bank accounts to cover the checks we have written.

To understand our spending behavior, let's visit some of the world's most accomplished savers by taking a trip to northern Europe. There we find forests where autumn arrives much as it does throughout the temperate parts of the world. Leaves change their color, temperatures plummet, and winds pick up.

Look down as you walk through the forest and you'll see a feverish acknowledgment of theoncoming winter. Red squirrels shift into overdrive each September, forsaking their summer life of leisure. In the course of two months, each squirrel will hide more than three thousand acorns, pinecones, and beechnuts throughout the several acres of their home range. It's hard being a squirrel.

Come winter, however, diligence pays off. With little food to be found on the bare trees, some squirrels are still living large. Each day they methodically move from one storage spot to the next as they ultimately recover more than 80% of their stashed snacks, enough to keep them alive until spring.

Hoarding for the future isn't restricted to rodents with big cheeks. It's a common response throughout the animal kingdom when lean times are ahead. Many bird species also store food in the fall. Nutcrackers, for example, bury seeds from pine trees and, like squirrels, show remarkable memory in finding their savings.

If there were a Savings Hall of Fame, it would contain dozens of animal species but certainly not the average American. How can humans (at least most Americans) be so much worse at preparing for lean times than squirrels, birds, and an ark full of other dim-witted creatures?

As described in the fable of the grasshopper and the ant, there are two strategies for dealing with abundance. The grasshopper plays all summer long while the ant works relentlessly to store food. When winter comes, the ant survives and the grasshopper dies.

Similarly, squirrels that work hard to store nuts survive the winter to have babies in the spring. When those babies grow up, they have the genes of their parents, genes that tell them to start burying nuts when fall comes. Animals are accomplished savers because natural selection favors the appropriately thrifty. Shouldn't the same forces have produced frugal humans? To understand the answer, we can learn by observing the behavior of people who live as foragers, as our ancestors did until recently.

The !Kung San live in the deserts of southern Africa. Until the 1960s they lived off this harsh land as nomads, gathering plants and hunting animals much as their ancestors had for ten thousand years or more. Because some San were still hunting and gathering into the 1960s, we have detailed records of their behavior in circumstances similar to those of our ancestors.

The !Kung San perpetually faced uncertain supplies of water and food. Building up reserves for the future would certainly help buffer those risks. Did the !Kung San save? Absolutely. The best opportunity for this saving came in times of windfall, usually after the killing of a large animal like a giraffe. With hundreds of pounds of edible giraffe meat, a hunter with a good savings system could live for months.

But !Kung San hunters had no meat lockers or freezers. Even if they preserved the extra meat, neighbors would descend and devour even the largest kill in a few days. Imagine your own "popularity" if you won the lottery, and you've got a pretty good picture of a !Kung San hunter with a dead giraffe outside his hut.

The !Kung San's behavior provides the clue to resolving the paradox between Americans' chronic undersaving and the strong evolutionary pressure to prepare for lean times. In a world without refrigerators or banks, preparing for hard times means eating enough food to store some fat on your body.

Although many animals, including squirrels and birds, do store food in the environment, most animals save by storing fat. Consider the interesting species called the elephant seal. A fully grown male of this species, at thirteen feet long and over two tons, is frighteningly similar in size to a fully loaded Cadillac. Females weigh in at a more demure half ton.

Each year, as the mating season approaches, elephant seals bulk up, with males loading on as much as two thousand extra pounds of body fat. Then, in an act of stunning single-mindedness that makes spring break in Miami look like Bible camp, the seals head for shore, and for three entire months they forgo all food, looking instead for love.

How do they survive? They draw from their substantial savings account. Before the ordeal winds down, they will lose more than a third of their weight. A male may shed more than a ton of blubber (and father up to a hundred babies).

So elephant seals save up for the mating season by storing extra energy on their body as fat. Humans, unfortunately, also save in this way. If you are a man, look down at your waist and grab the flesh that covers your stomach. If you are a woman, look at your thighs and buttocks. What do you see?

From one perspective you see hated fat, but from an evolutionary perspective you are looking at a savings account with a substantial (and possibly growing) balance. Evolution has produced a world of accomplished savers; humans, like most animals, simply save in the currency of body fat.

How good an evolutionary saver are you? In 1981 Bobby Sands, a member of the Irish Republican Army, went on a hunger strike to protest British policy. He was not a fat man to begin with, yet it still took him sixty-six days to starve himself to death. Many of us would survive, albeit unpleasantly, for more than two months without a single morsel of food. That's a pretty impressive savings account! Perhaps we deserve a place in that Savings Hall of Fame after all.

Consider an ancestral human who had just won a prehistoric lottery. He or she has, for example, just killed a wild pig or found a tree bursting with juicy mongongo nuts (not too different from macadamia nuts). With today's markets and financial instruments, this winner could sell the surplus and put the resulting cash in a bank.

For our ancestors, however, saving through markets and money was not an option. Successful people would ram as much as possible into their own stomachs and those of their genetic relatives. They might also share with non-relatives who would repay them on their good days. In such an environment, the best way to save is, paradoxically, to consume. Rather than leave some precious energy lying around to mold or be stolen, put it in your stomach and have your body convert the food into an energy savings account

When you're a mammal, food is the coin of the realm. Genetic mechanisms prod squirrels to mind their nuts and elephant seals to pad their flanks. As we struggle to save money, our mammalian heritage lurks in the background. We know we ought to put some money in the bank, but consuming just feels so good.

* * *

Don't eat the nest egg. Proud as we may be of our hardy forebears and their genetic legacy, most of us would be happier if we could act less like victorious cavewomen and more like Scrooge. To prosper in the industrialized world with its refrigerators and government-insured bank accounts, we need to trick our ancient genes.

Because we evolved to consume everything in sight, many of the most successful savings techniques involve hiding money from ourselves. By making ourselves feel poor, we can induce our overconsuming instincts into living more frugally. One well-known technique is carrying less cash. By doing this we fool our genes, at least a bit, into thinking there is less surplus to be consumed.

In the movie The Border, Jack Nicholson comes home to find his house filled with expensive new furniture. When he asks how much it cost, his wife replies, "We don't have to worry 'bout payin' ... I opened up a charge account!" A danger of using credit is that we do not hand over anything that feels valuable (such as cold, hard cash), so charging doesn't feel like spending money. In the quest for restraint, a credit card is worse than a debit card, a debit card worse than paying with cash, and paying with cash worse than not spending.

As a variation on this ruse, many people find multiple bank accounts useful. One account is untouchable and can accumulate savings, while the more commonly used account, usually the checking account, gets fixed transfers each month. The savings account should be as hidden as possible. For example, it can be in another state with no associated ATM or debit card. Or at least in a bank with ATMs located only in distant locations.

Easy access is our enemy. Ironic as it is, the best bank for our savings may be the one that makes withdrawals as difficult as possible. We can, for example, choose an account that pays a high interest rate but has outrageous fees for every transaction.

People don't come into the world with instincts for appropriate financial behavior. Most of us need to learn, and this learning frequently involves some painful mistakes. We (Terry and Jay) have been there, so we know.

Early in his financial life, Jay discovered the joy of credit cards. Freed from the tiresome need to have actual cash for purchases, he enjoyed an extended spending spree. But he soon learned that credit-fueled feasts end with maxed-out accounts and monster monthly payments that barely make dents in the balances. Each purchase felt like a one-time event — a necessity — but he quickly dug himself into a deep financial hole. (Fortunately, further digging was prevented by the financial companies canceling all of his credit lines.)

Jay's first solution was to switch to a card that required him to pay the entire balance each month. This led to some tough months, including last-minute scrambling to raise cash by selling CDs and books. It also brought his charging down to a manageable amount. Still, although he always scraped together just enough to stay out of debtor's prison, Jay never had a cent left over for the savings account that might someday become a down payment on the beach house he dreamed about.

That's when Jay's credit card company stepped in: it offered a new plan that would bill an extra amount to your credit card each month. This seems like the wrong kind of progress. How did having even more to pay help Jay save money? The trick was that the extra amount billed was invested in a mutual fund. This made the monthly adventure of paying off the card even more harrowing, but it worked. He always figured out a way (and little by little it came from charging less), and by doing so he accumulated $250 every month in savings.

One of the most effective savings mechanisms for us is to hide money. Who are we hiding it from? From ourselves or, more precisely, from that more impulsive part of ourselves. Jay was able to begin saving only by setting up a separate account that he never saw and that was extremely difficult to access.

If you have a job, you are already hiding some money from yourself in the form of social security. Although it is not technically a savings plan, social security helps us save for retirement. Essentially, the more we earn, the more the government will pay us each year when we are retired. For all of its well-documented flaws, social security has worked to ease poverty among older Americans. When the program was enacted, people over 65 were the poorest segment of the American population. Now they are the richest.

Another proven way to save, successful precisely because it doesn't feel like saving, is to buy property. Although the average sixty-year-old American has only $8,300 in financial assets, retirees have over $35,000 in the form of home equity. Failing to keep up the mortgage payments can result in losing the property, so even terrible savers turn out to be surprisingly successful at scraping together enough to avoid default.

In the 1980s, Brooke Shields made a series of racy advertisements for Calvin Klein jeans. In one she says, "When I get money, I buy Calvin Klein. If I have anything left over, I pay the rent." Successful savings techniques share a bit of this seemingly warped set of priorities.

Effective savers can say, "When I get money, I lock some up as savings. With the money that's left over, I purchase food and shelter." People save when the money comes out of income before other needs. As long as the amount of savings is fixed and required in the form of a mortgage payment or payroll deduction, most people find a way to make ends meet. If savings are simply whatever money is left over after buying, the result is usually no savings at all.

Setting up mechanisms for automatic savings can be incredibly painful, but nearly everyone gets over the pain and adjusts to their new income. Mortgages and secret mutual funds are just peachy for rich folks, but what about those of us who are hanging by a financial thread?

The trick is to pick the right time to increase the amount of hidden money. For example, when we get a raise, we can increase the contribution to our retirement account so that our take-home pay remains constant. We can whine all we want, but we know it's possible to live on the old salary because we actually did.

With growing government surpluses, it's also likely that we'll get a tax cut in the next few years. If so, that will be another excellent time to ratchet up the savings. Similarly, any windfalls such as tax rebates and gifts are best invested immediately.

The book The Millionaire Next Door describes the behavior of average folks who became wealthy. The surprising conclusion is that most people get rich because they spend less, not because they earn more than the average. Millionaires, for instance, hold off an extra year or two before trading in their decidedly non-exotic cars and are more likely to sport a Timex on their wrist than a Rolex.

* * *

Saving more. Why do we need so much help saving money while other behaviors come so easily? The answer is that we need little help learning behaviors that have been critical to human survival and reproduction for thousands of generations. We instinctively solve ancient problems, and it's only when our instincts fail us that we've got to buckle down and learn. For a dramatic example, consider how babies react to dangerous objects.

Place a loaded pistol in a playpen and the babies will play with it just like any other toy, giggle, and perhaps even place the gun in their mouth. In contrast, put a plastic snake into the playpen; the babies will cower in fear. Show a person of any age a snake — or even a picture of one — and you will elicit a dramatic response, including sweaty skin and an increased heart rate. It doesn't matter whether the person is in America, Europe, Japan, Australia, or Argentina, the response is the same. This is true even in Ireland, which has no native snakes.

Why do we have an instinctive fear of snakes and not of guns? In 1998, guns killed more than thirty thousand Americans; snakes killed fewer than two dozen people. In the United States, you are literally eight times as likely to be struck by lightning as killed by a snake. Nevertheless, snakes produce one of the strongest instinctual fear responses.

We ought to be very afraid of guns and relatively unconcerned by snakes, but we are built in just the opposite way. A bit of reflection resolves this puzzle. The genes that cause instinctual fear, like all genes, have been handed down to us from our ancestors. Snakes caused many human deaths when we lived as hunters and gatherers. In contrast, guns didn't kill a single person until very recently. Accordingly, we loathe our ancient enemy, the snake, and have no instinctual response to novel threats regardless of how deadly.

Other primates are also killed by snakes and have the same genetic hatred. Even adult chimpanzees and monkeys that have spent their whole lives in zoos and have never seen a snake share our instinctual herpetological fear. They become terrified and agitated immediately on seeing their first snake.

In contrast to our long evolutionary history with snakes and other animals, try to imagine the following conversation between your great-great-great- ... great-grandparents as they sat around the campfire ten thousand years ago:

Husband: "Honey, I'm thinking of putting 25% of our savings into floating-rate Japanese bonds with an option to swap into Eurodollars. What do you think?"

Wife: "That's crazy. Over many thousands of generations, we've all learned that stocks are better investments because of their higher long-term return and more favorable tax treatment. All humans know to invest in technology firms. I hear that Fidelity has a new fund for investing in companies that can make fire."

Ridiculous. Our ancestors knew nothing of financial instruments. Accordingly, we are no more likely to have instincts to make arcane financial decisions than we are to fear guns. Our instincts for saving for the future simply aren't wired for modern financial choices. Maybe in a thousand generations but certainly not this fiscal year.

Our ancestors would obviously be confused by many modern financial choices. They'd even be ignorant of money, another modern invention. Let's consider how recently humans developed money.

The first ways to borrow and save used food as currency. In Lapland, all the way through the nineteenth century, people settled debts and secured housing for the winter with payments of cheese. Now, using cheese to pay the bills is not much of an improvement over Mother Nature. Elephant seals save via fat on their brisket while these Laplanders used fat-filled cheese in their baskets.

More recently, we have learned to amass more easily exchanged currencies. North American natives and settlers used the proto-currency known as wampum, purple and white beads made from shells. Moving south, cocoa beans were long preferred in Central America. Although they wouldn't last forever, they were easy to count, pleasant to handle, and you could always eat them in a pinch. Try doing that with a quarter.

And speaking of quarters, when exactly did we move beyond all of these essentially animal-like methods of storing value? When did we finally envision our modern concept of money?

The first minted coins appeared in the kingdom of Lydia, a center of international trade around modern Turkey and Greece, at the beginning of the seventh century B.C. The idea didn't exactly catch on like wildfire, though. As a Japanese proverb of the time states: "Wise rulers in all ages have valued cereals and despised money. No matter how much gold and silver one may possess, one cannot live for a single day on these. Rice is the one thing needful for life."

The difficulties of money are compounded at the intersection of cultures. Imagine the plight of the French singer Mademoiselle Zelie. In the course of a Pacific Ocean tour she played a concert in the Society Islands and received in payment her standard one-third of the box office.

Much to her chagrin, however, this amounted to three pigs, twenty-three turkeys, forty-four chickens, five thousand coconuts, and considerable quantities of bananas, lemons, and oranges — literally a third of what the box office collected. This would have been worth a considerable sum in Paris, but without an ark to get it home, it was virtually useless.

For the two and a half millennia that it has been possible to stockpile wealth in the form of coins, people have resisted. Old habits die hard, especially when they're in our genes. The chief drawback to money, of course, is that coins have value only to the extent that you can trust other people. Unlike the cocoa beans or rice, coins have no intrinsic value. As a consequence, right on up to the last century, we've got Laplanders assuring their skeptical landlords that "the cheese is in the mail."

Our brains are built by genes that excelled in a world without money. When it comes to padding our bodies with a bit of fat, we have powerful instincts. Similar instincts for minding our cash haven't had time to evolve.

If we take our snake experiment to the highlands of New Guinea, we have a hard time finding the same fear of snakes. Showing snakes or pictures of snakes amuses adult New Guineans. It doesn't frighten them. This seems a bit odd. Why the difference from nearly every other society tested? In New Guinea, unlike New York City, snakes abound and still kill many people. There is even one recorded case of a massive python killing and completely consuming a fourteen-year-old boy on a nearby Indonesian island.

If anyone should be terrified of snakes it would seem to be the New Guineans, who are still killed by them. Instead they laugh at our naive, generalized fear. Experience and learning are the explanation. From the time New Guineans are small children, they encounter snakes — only a third of which are poisonous — with great regularity. In the process, they learn to identify the nasty and the harmless snakes, often capturing the non-poisonous ones for eating.

The New Guinean naturalists have learned to modify our innate fear of snakes, capitalizing our big brains' ability to alter the program. Similarly, while babies show no innate fear of guns, people quickly learn the appropriate response. From these victories in modifying our instincts, we can gain inspiration for transforming our relationship with money.

Can people really change such firmly entrenched behaviors? Absolutely. The truth is, they're not even that firmly entrenched. It only feels as if we've been in debt forever. In fact, the number of people going bankrupt in the United States has changed by 300% since 1980. Although the change has been in the wrong direction, it shows we can change. The same applies to American savings behavior, which has moved steadily toward more spending in the last two decades.

Further evidence of our ability to save comes from other cultures with more frugal ways. Ironically, as hard as it is for Americans to boost their savings rate, the Japanese economy has stagnated from exactly the opposite problem: too little consumer spending. So while our instincts prime us to consume too much, Japanese frugality proves that those instincts are malleable enough to allow good savings behavior. Our real problem is that we are too flexible in our savings behavior. Companies know this weakness and attempt to manipulate us for their profit.

* * *

Buy me on credit! Financial firms make money the old-fashioned way, they charge high interest rates when they lend us money and pay low interest rates when we park our savings with them. In search of profits, the firms prey on our poorly honed financial instincts and exploit some of the quirks in our genetic legacy. Knowing their tricks can help us navigate the modern financial jungle.

Take Homer Simpson. He orders virtually every product that is advertised on TV. He sees someone with a shapely physique and immediately orders the twelve-cassette package that will teach him to lose weight. The cassettes are shipped immediately, while the money will not be due for ninety days or more. Homer's impulsive buying is funny because it is only slightly more impulsive than our own.

It's as though our brain can't quite grasp that money doesn't lose its value over time. As a matter of fact, that's exactly the problem; our brains were built for a world in which the currency of the day did lose value over time. Put simply: food rots. In that world, the savvy investor ought to devalue future payments severely. Unfortunately, our brain plays by yesterday's rules, so we are an easy mark.

Sure enough, companies do exploit our built-in impatience and often succeed best when appealing to our desire to have it all now. The ability to take home a fabulous washer-dryer set today, with no payments for sixty days, tickles the fancy of that little hunter-gatherer deep inside us. Never mind that in the end we will pay far more than we think is fair. At the time of purchase, our outdated instincts guide us in the proper balancing of value today against costs to be paid in the future.

The road to Hell, it is said, is paved with good intentions. We often waste money when we expect to change for the better but instead continue our impulsive behavior. In an investigation of good intentions, researchers studied people's willingness to watch serious movies.

In one group, subjects were asked to choose a movie to watch for that night. In the other group, subjects were asked to choose movies that they would watch on each of the next three nights. For this group, the movies would be viewed over the three days, but the choices were all made on the first day.

An interesting pattern emerged. When choosing for tonight, people in both groups selected lighthearted romances, comedies, and action films. When choosing for future evenings — tomorrow or the next night — people selected more serious films, such as Schindler's List, which portrays Nazi concentration camps, as well as films in foreign languages.

On day one people said, "I'll watch something fun tonight, but tomorrow I'll watch a film I ought to see." When tomorrow came, however, they again wanted to have fun and would have switched to Groundhog Day if possible.

Companies know that we are overly optimistic about our future behavior and use this knowledge to make money. For example, they offer us credit cards with a low introductory interest rate. The catch is that the interest rate will increase substantially after six months. There's nothing illegal about this. The banks don't even have to hide these terms in the fine print (though they always seem to). They could put them in neon lights on a billboard: YOU'LL PAY SUPER-HIGH INTEREST RATES, BUT NOT FOR SIX MONTHS.

Because of our relentless optimism that the future will be different — and better — than the past, we flock to these sorts of deals. (If aliens ever conquer Earth and keep humans as pets, they'll probably view this irrepressible optimism as our most endearing feature.)

When we sign up for such plans, we look forward to a new and improved us and expect to take the firms for a ride. We don't really care if they're going to charge us exorbitant interest rates in six months because we plan to be debt-free (and thinner) soon. When the six months end, though, we are usually still saddled with our debts. One result is that the average American torches a fifth of his or her income on credit card payments that are mostly just interest.

* * *

Taking control of our finances. How can we prosper among the loan sharks and a sea of tempting offers designed to stimulate and exploit our desires? Well, we can't rely on our instincts. Instead, we need to continuously hone our financial training. We have to turn the tables on banks and businesses by doing to them exactly what they do to us. Remember, they make money by charging high interest rates on the money we borrow and paying low interest rates on the money we save.

Step 1 in turning the tables is to think of everything in the same currency, namely after-tax interest rates. Regardless of whether something is called a loan application fee, an interest charge, or a balloon payment, all that matters is the interest rate. A variety of excellent books and software programs exist to help us convert costs of all types into an effective interest rate. With a concerted effort, anyone can do the required calculations. As obvious as this may seem, many of us don't even know what interest rates we are currently being charged.

Step 2 is organizing your financial house. Whatever debt we have should be at the lowest possible interest rate — and tax deductible if possible. Similarly, whatever savings we can accumulate should produce the highest possible after-tax return.

For example, if we owe $3,000 on our credit cards and have $2,000 in a savings account, we are giving money away. Savings accounts pay paltry interest rates, in the 2%-3% range at best, while credit cards charge a rate closer to 20%. We can act like Wall Street bankers by using some of the savings to decrease the credit balance. Money that was earning us 2% instead will now save us the 20% we are being charged.

At one level this need to organize and rationalize our finances is obvious, but at a deeper level it requires us to suspend our instinctual response to tempting offers. This is all the more difficult because firms are always designing, consciously or otherwise, programs to fool our intuitive concepts of value.

Step 3 is to be realistic about our own behavior. This may be the hardest thing of all when it comes to managing money. Even though we think we'll do better tomorrow, the best predictor of our ability to rein in future desires is our past behavior. We shouldn't expect to sit through three hours of an obscure documentary when Austin Powers is on cable. Similarly, we shouldn't accept financial offers that will save us money only if we become completely different people.

Finally, take advantage of firms. Although each company is trying to gouge us as much as possible, they are competing for our business and may be forced to offer great deals. For example, a phone company may have an introductory low-price deal or some sort of signing bonus. It's betting that we'll stick with it when the offer ends. However, we can take the freebie and move on to another offer before the deal gets worse for us. Companies hate consumers who jump from freebie to freebie, but it's legal and profitable.

Evolution has produced elegant solutions to many problems. If we stumble physically, our bodies' systems react instantly to catch us or minimize the pain of the fall. There are no instinctual protections in the financial area. With every major decision, we must suppress our gut response and use our learned financial tools to make the best choices.