Financial Retronovation #1: Earmarking Income

By Corey Stone, Entrepreneur in Residence, CFSI

Unless they have time to kill, on-street parkers who forget to bring enough change for the meter place themselves in a land of limited options. They can keep their appointment, but risk a parking ticket, or they can run in search of change and be late. Many who choose to be on time end up guessing how long they will stay, hoping the meter minder is on another block, and miscalculating their risk. For decades, this behavioral formula has helped provide municipalities with a dependable source of parking ticket revenue.

That is, until citizens were offered a new option. My last post highlighted how smarter technology has taken the guesswork out of feeding the parking meter. Now more people pay more reliably for their parking spaces and incur fewer tickets. Similar new tools are giving cash-strapped consumers ways to avoid overdrawing their accounts and the fees that causes. My next few posts focus on these tools and how they differ from past innovations in consumer payments and deposit accounts.

One important way to avoid running out of money at the ends of the month is to set aside or “earmark” money as it comes in for bills you know you’ll need to pay.

For over a century the US Military has helped service members do exactly that using a system of payroll deductions — called “allotments.” Allotments assure that young soldiers reliably use their pay to meet their families’ most important financial obligations. Payments for rent or mortgages, insurance policies, and savings plans to which a servicemember has committed are paid directly by the Defense Department. The servicemember sees a deposit into her bank account that is reduced by those amounts. The reduced deposit leaves a more accurate picture of her remaining discretionary income. Automatic allotments have withstood the test of time in helping young families who live on entry-level salaries adopt financial discipline.

My wife encountered a cash version of this sort of financial discipline 30 years ago when she ran the finances of a small manufacturing company. Most of the workers were skilled craftspeople and it was common practice for them to take their biweekly paychecks home to their spouses, who would cash the checks, allocate the cash proceeds to different paper envelopes (e.g. mortgage payment, car payment, utilities, groceries, gasoline, etc.). What was left over was divvied up between savings, and allowances for discretionary expenses. The system kept families from spending pay that needed to be set aside for big bills that came due each month. It worked well in cash but required a high degree of self-discipline and family coordination.

Basic financial literacy courses have long advocated similar manual systems for earmarking income for recurring bills and basic necessities. But these systems haven’t translated well from the cash world of a generation ago to today’s world of ubiquitous electronic payments. Cards and other forms of electronic payments have helped do away with the inconvenience of using cash, and they have fostered the explosive growth of electronic commerce. But today’s frictionless payments have made it harder to practice the sort of spending discipline my wife’s old-school colleagues practiced and that our military continues to provide automatically to servicemembers.

Market research shows many consumers facing tight budgets employ a grab-bag of home-grown tactics to sequester income they know they’ll need for future bills. Some squirrel away cash so it remains hidden from spouses and children. Some keep separate accounts at different institutions that aren’t easily accessible. Some prepay their bills so they aren’t tempted to spend the funds on impulse purchases. These improvised steps are attempts to re-introduce friction to spending and make up for habits we lost when we gave up cash.

Now some fintechs are introducing digital versions of the envelopes approach. Several years ago, Simple, a challenger bank that is now part of BBVA Compass Bank, introduced an automatic, short term savings feature to its basic checking account called “Goals.” Simple designed the feature to enable users to save for large expenditures, such as a major purchase, a tuition payment or a down payment on a car. Money earmarked from income for these discrete spending goals was removed automatically from the account holders’ “safe-to-spend” balance.

Uptake of the Goals feature was high. But Simple was surprised to see that most of the Goals customers set weren’t for the big one-time expenditures they planned to make months or years out. Instead, most were using the feature for recurring monthly obligations such as rent. Most of the customers were paid biweekly or semi-monthly and Goals in effect created sub-accounts that enabled customers to earmark portions of their paychecks for bills they knew would come due two, three, or four weeks ahead.

Simple has recently added a modified version of the “Goals” feature that it calls “Expenses.” It is explicitly designed to enable users earmark portions of their income for future bills and remove these funds from current spending. Digit, an automated savings app, has introduced a similar feature. And Finicity, the data aggregator, recently purchased Mvelopes, a digital app that performs the same earmarking function.

These new digital envelopes constitute a “retronovation,” harkening back to an era when many more of us conducted our financial lives in cash. In some ways, smart parking meters do the same: our grandparents carried around a lot more change than we do (does anyone remember coin purses?); and that upped the odds they’d have enough coins for the parking meter. The new mobile parking apps let us feed the meter using the ways we pay today.

Debit cards and then digital wallets made it easier for consumers to pursue any opportunity for instant gratification with all their liquid assets at their disposal. Now, many are choosing the new digital envelopes to help shield their future selves from their impulsive present ones, cordoning off funds they know they’ll need for what’s most important. That could help them limit their discretionary spending earlier in the month. And with a little bit more left over at the end, they might overdraft less.

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Retronovation n. The conscious process of mining the past to produce methods, ideas, or products which seem novel to the modern mind.” —

Read the next entry of the Ends of the Month blog series: Financial Retronovation #2: Resurrecting the check register…with an AI assist