How To Automate Your Finances
Today’s post is a follow-up to Monday’s post on the easiest way to get rich. Automating your finances will both make it easier to manage your money on a daily basis AND put you on your way to building real wealth. But where, exactly, do you start?
Five Steps to Automate Your Finances
1. Open the Necessary Accounts
For automating to work, you’ll need at least two checking accounts and three savings accounts. I keep my accounts at two separate banks. Our main checking account is at USAA, and my fun checking account and multiple savings accounts are all kept at Ally. (Good news – Ally just raised their rate to 1.35% on all savings accounts!)
There are no fees with Ally or account minimums, so go ahead and create all the savings accounts you need. It’s much better to have individual accounts for all your short-term savings – such as travel, holiday gifts, and home renovation – then it is to “forget” you need to save money for something. “Forgetting” often leads to relying on your credit card and depleting your emergency savings. Not good for building wealth. Other short-term savings could include insurance you pay yearly, a pet fund for your dog’s yearly bills, or saving for a wedding.
You’ll also want to open a credit card with a good rewards program. I’ve used Barclay for years, which offers around 2.1% cash back on all travel expenses. Have all of your regular monthly expenses that you can automatically charge this card. Note: if credit card debt has been an issue in the past, steer clear of this and use bill pay through your main checking account.
2. Set-Up Your Automatic 401(k) contribution with your employer.
Now, fill out the paperwork so that your HR will automatically withdraw from your paycheck your contribution to your 401(k). If your employer matches a certain percentage of your income, make sure you contribute at least that amount. A match of 3% is common. This means you’ll need to contribute 3% of your paycheck to get a 3% match and 6% of your paycheck will be deposited.
I believe most high-income professionals should try to max out their 401(k)s. That’s contributing $18,500 a year or $1541 a month. Keep in mind that because a 401(k) is tax-deferred, you won’t actually have the full $1541 taken out of your paycheck. It’ll feel more like $1000-1200 missing, not the full $1541.
A 401(k) can be a powerful retirement tool. Let’s say you work from age 26 to 35 at your first job post-graduate school. During that time you save $100,000 in your 401(k). That’s about $925/month, less if you have a match. Then you switch jobs and do nothing else to your 401(k), leaving it in a target index fund set to when you turn 65.
30 years pass. You grow up, your kids grow up, your set to retire. You remember once upon a time you had a 401(k).
That 401(k) is now worth $1,000,000. A cool million all from work completed before the of age 35. At a 4% withdrawal rate, that’s $40,000 of retirement income to supplement any other retirement savings and Social Security. Not too bad for 9 years worth of savings after graduate school.
If you can’t contribute the full amount to your 401(k), start with at least the match and work up to a full max over the next two years.
3. Set-Up an Automatic Transfers from Your Main Checking Account into Savings and Fun Account.
Next, determine how much you need to have deposited into your monthly savings accounts. For example, I have $100 deposited each month into a Holiday/Wedding Gift savings account.
You’ll also want to contribute to an emergency fund until you have 3-6 months worth of expenses. Once you’ve saved your emergency fund this money can be invested.
With this step, you’ll end up with 3-5 transfers that either occurs monthly or when you’re paid. For example, I could have had $50 transferred every two weeks when I’m paid instead of at the beginning of the month.
Finally, set up a transfer to your fun checking account. This is money that can be spent on anything with no guilt and no fear that it will delay your path to financial independence. Mr. Graduate Investor and I use our fun money for all personal purchases, including clothing, books, video games, lunches out, coffee breaks, and random purchases.
This account is a gamechanger. In today’s world of constant marketing, advertisement, facebook, and Instagram – this account lets you indulge without blowing your whole financial plan. Because sheer willpower isn’t enough. And it’s unrealistic that you’ll actually eat Ramen every night, or remember all your yearly expenses everytime you debate an impulse buy.
When you see something you want to buy, if you have the money in this account you can buy it. As simple as that. Treat your self.
4. Set-Up Automatic Payments of Mortgage/Rent and Student Loans.
Now is the time to spend 30 or 45 minutes to save yourself a lot of monthly hassle of paying bills. Login to your mortgage, rent (usually this can be automatically billed) and set up an automatic bill pay through your bank account to have these paid each month.
You can also set-up your credit card bill to be automatically paid each month. I prefer to pay mine on a weekly basis, but if you’re prone to forget and have had late fees in the past go ahead and make this one automatic too. Keep in mind that because your credit card is now being used for planned purchases (like Netflix or your electric bill), there’s a lot less concern of spending too much on your credit card. Your bill will be substantially the same month after month.
5. Sit back, relax, and periodically Glance At Your Balances.
Now that everything is set-up – your automatically saving and paying all your bills – it’s time to sit back and relax. You no longer have to worry about missing a payment and getting hit with a late fee. Or worse yet, not having money when you want to buy that birthday gift or go on a weekend trip with your friends.
Your daily spending will also be under control. I’m a firm believer that many of those with middle to high incomes “leak” a lot more money than they realize. $20 here, $40 there – it adds up fast! The sheer number of transactions in a month can seriously undermine our ability to building savings, reduce debt, and gain wealth. The best way to stop the leak is to use your fun checking account for all daily spending. It’s much better to have it declined once or twice because you’re getting used to being on a budget (true story) then to have to choose between paying your mortgage or your credit card.
At this point, the only work left in managing your money is to check-in on your balances periodically to make sure all is going as planned.
So, what are you waiting for? Instead of relying on sheer willpower every day or remembering every expense you have coming up the next year, take 30 or 45 minutes now and automate your finances. Then come back and let me know how it goes!