Simply put: the easiest way to ensure your financial success is to know how to automate your finances. It takes some time to set up, and a little bit of maintenance, but is almost completely hassle-free.
Automating your finances gives you clarity and power over your finances, and, it scales infinitely so you’ll never grow out of it.
You’ll need several different accounts to accomplish this task: I have 2 checking accounts and 3 savings accounts.
This doesn’t include my investment accounts, which I also have 3 of (Roth IRA, Traditional IRA, and taxable investment account).
Step 1: Set Up Automatic Deposit
The first step: set up automatic deposit for your paycheck. Your income should be deposited directly into a specific savings account–any savings account is fine. The purpose of this account is to delegate funds to specific accounts.
Step 2: Set Up Automatic Bill Payment
Your pre-negotiated bills, like rent, electricity, gym memberships, insurance and subscriptions, are important expenses.
Paying all of your bills on time every month is a prerequisite for financial health.
Set up automatic transfers into a checking account called Yesterday’s Promises (because you’ve already agreed to pay these bills). Automatically pay your monthly bill from this account.
For bills like electricity and gas, which vary, I recommend you set up a minimum auto-payment that is approximately equal to your highest monthly bill from this vendor. You can edit the amount each month if you remember to, but in case you forget, the worst case scenario is that you’ll build up a credit balance with the vendor.
The amount you transfer into this account is the amount you owe on the sum of your pre-negotiated bills.
Step 3: Set up Auto-Transfers to Other Accounts
After you’ve set up Yesterdays’ Promises, calculate how much money is left from your paycheck. Then you need to decide how much of that number will go to short and long-term savings.
I have savings accounts called Curve Ball, All Things Auto and Vacations & Gifts.
The Curve Ball account is for when life throws you curve balls–some people refer to it as an Emergency Savings account, but I don’t have financial “emergencies” anymore since I have planned for unexpected scenarios. The Curve Ball account should have 3-6 months of expenses in it. Once you reach that balance, you don’t need to transfer money into that account anymore.
Now set up your auto-transfers into the various savings accounts.
NOTE: I have assumed that your retirement savings accounts are either 1) Your employer-sponsored 401(k), or 2) at a different institution than your retail bank.
Set up your maximum retirement account savings first. It’s the most critical.
Your other savings accounts are for expenses like a new car, auto repair and maintenance, or a vacation–hence their names!
Your final auto-transfer to set up is into a checking account called Today’s Fun. This is for your discretionary spending on things like groceries, meals out, food, gas and incidentals. Don’t decide how much goes to discretionary spending first, that puts spending before savings, which is bad.
You might be thinking, “Wait! Groceries are a necessity!”
Yes, but we often make choices to go out for a meal instead of eating the groceries in the fridge, and Americans are known to let a full 25% of their groceries rot!
The important thing to remember with this account is when it gets down to a balance of $0.00, you are not allowed to spend anything else. The funds you have allocated to go into your savings accounts must stay there, regardless of whether you’d prefer an extra night out.
If you’re following along with the process I’ve outlined in your mind, you’re starting to get the picture that another prerequisite for financial health is having the lowest monthly obligation you possibly can.
Keep that Yesterday’s Promises number low, and everything else can breathe.
This is where you should make your sacrifices: rent well below your ability, pay cash for cars instead of taking a loan, don’t sign up for things that obligate you on a monthly basis because it removes your ability to make the choice between that expense and another each month.
If you want to read more on how I keep myself from overspending, check out this blog post.
I’d love to hear from you about financial systems that work! Give us your tips in the comments below.