If you would be wealthy, think of saving as well as getting.

– Benjamin Franklin

The symptom: Account transfers appear to be savings.

The example: Last year you saved €500 every month by transferring the money from your checking account to your savings account. This year, however, that approach just does not seem to be working. There never seems to be enough money in the checking account to transfer. You are puzzled because both your income and your expenses appear to be about the same as last year.

So what happened? The first and most obvious possibility is that money is simply being transferred from one asset account to another. In other words, someone might be gradually drawing down their checking account (or other asset) and transferring it to their savings account. While this might be a reasonable investing decision, it is not saving money. For example, start with the following scenario:

€1,500 (checking account)
€5,000 (savings account)
——
€6,500 (total = net worth)

Then transfer €500 from checking account to savings account…

€1,000 (checking account)
€5,500 (savings account)
——
€6,500 (total = net worth)

Notice that the savings account grows, but not net worth. No money is being saved by the transfer. Thus, the first lesson to be learned from accrual accounting is that account transfers are not savings. If there were any savings, they occurred earlier when income exceeded expenses. The transfer has nothing to do with it.

Another possibility is borrowing. Not paying down recent purchases on a credit card could be the source of the cash. For example, start with the following scenario:

+€1,500 (checking account)
+€5,000 (savings account)
–€1,200 (credit card)
——-
+€5,300 (total = net worth)

Then draw down €500 more on a credit card and not pay it back. Transfer that money to savings account.

+€1,500 (checking account)
+€5,500 (savings account)
–€1,700 (credit card)
——-
+€5,300 (total = net worth)

Again, no money is being saved. It is easy to see that the increase in the savings account came from borrowing. Unfortunately, real budgeting issues will not be as straightforward as the examples shown above. Households tend to have very irregular cash flows. It may not be so easy to spot asset transfers and borrowing masquerading as savings.

Certainly borrowing is not saving money. But also notice that the act of borrowing by itself is not an expense! Again, it is just moving money around. However, any fees and interest you pay on the borrowed money are obviously an expense. So if borrowing money does not decrease your net worth, what is the problem with borrowing?

The problem with borrowing is what you do with the money after you borrow it. If you spend the borrowed money on something that decreases your net worth (i.e. an expense), then the real problem is spending, which may be compounded by the fact that in extreme cases, the borrowing enables you to spend what you otherwise could not. Most chronic personal finance problems are either income problems (e.g. unemployment) or spending problems. “Borrowing problems” are usually just income problems or spending problems in disguise because borrowing can temporarily mask income problems and enable spending problems. Borrowing can also cause a cash flow crisis if you cannot pay the money back according to schedule. Thus, borrowing increases risk.

Additionally, the interest and/or fees on the money are often much higher than what you might gain from the borrowed funds. In the above example, why borrow money from a credit card at 10% or 15% to fund a savings account at 2%? Financial markets are usually reasonably efficient. Generally speaking, the markets are not going to let you borrow money at a rate that is much lower than the return you could get from investing in financial instruments.

For non-financial assets, however, this may be a different story because you may be able to indirectly profit from certain scenarios. For example, the return on certain small home insulation projects can be huge. If you really had to borrow €20 to buy a few tubes of caulk, you might come out way ahead, not because you are making money on the caulk, but because if you apply the caulk to a badly sealed house, you could quickly save several times that amount of money in heating. The same could be true with borrowing money for a car to commute to work. While the car will go down in value, a good job could contribute substantially to your income, and overall it would be a better situation than staying unemployed for lack of transportation. Similarly, people are often surprised to learn that after interest, taxes, repairs, and other items, they often do not make money on their main residence. However, in many cases it still makes sense to purchase because you have to live somewhere and in the long run it may be much cheaper than paying rent.

Now clearly a person cannot go on forever draining down their checking account or borrowing money to fund their savings account. Eventually they will “figure it out”. However, there are several reasons why you do not want to wait until cash flows indicate there is a problem.

1. The poppycock could go on for a very long time – months, even years.
2. In the mean time, you are left with the misleading impression you are savings money.
3. Since you assume your financial picture is rosier than it really is, you may exacerbate the situation by spending more than you otherwise would.
4. Even after the point is reached where transfers are no longer possible, you may waste a lot of time trying to find a recent change to your financial situation. Yet the reality might be that nothing has changed! The savings were simply never there in the first place!

If you use budgeting software of any kind, here is an interesting thing to experiment with for a few minutes. Only in your budgeting software (not in real life), try transferring money from any account to another account – any transfer at all. Move €500 from your checking account to your brokerage account. Pay off €500 of your credit card balance. Make an extra €500 principal payment on your mortgage. Borrow €500 from your home equity line of credit. (Remember to delete all these hypothetical transfers when you are done experimenting.) What happens to your net worth after you make each transfer? Absolutely nothing! With the possible exception of any transfer fees, your net worth is exactly the same as before! Thus, an account transfer is neither savings nor an expense. It is simply moving money around.

It may seem obvious that savings results from income exceeding expenses and not merely from moving money around. On the other hand, if you ask someone how they know that they are saving money, they almost invariably respond that their savings account of choice has increased. In other words, money has been transferred to that account. A few people might indicate that their expenses are less than their income, but unless their “income” and “expenses” are accounted for properly, their “savings” may be only a mirage.