Systematizing Your Savings

A few years ago, I got really into personal finance. I’d research all sorts of minutia about various types of accounts, tax laws, etc. I spent a lot of time learning about the topic. But like most things, the Pareto distribution also has a major influence on this topic.

After wasting a lot of time optimizing things that really didn’t need to be, and adding additional complexity where there really was no need for it, I figured out a method for both simplifying my relationship with my finances as well as automating the process, and I’d like to share it in the hopes that at least one of you may benefit from it.

1. Where To Start?

The first important thing to note is that your choice of tool is very important to being able to complete the job. I’d suggest using a bank that’s oriented around online banking. I recommend Ally, it’s what I personally use and I really like it overall. The reason for this is that in order to put this into practice, you need to be able to generate savings accounts at-will and create automated transfers.

Ally also seems to have some of the highest savings account rates I know of, and while they may not be the absolute highest, they’re “good enough” and already a part of a good product to use for creating this system. The point isn’t to complicate things by having varied accounts on different platforms to eek out an extra half-percent per year. It’s to be good enough.

2. The Great Filter

The first thing is to set up a checking account. This checking account should act like a main function, the entrypoint to your finances through which all incoming funds should go. Think of it like an email inbox; you want to receive all of your fiat through it. If you receive a paycheck or regular payments from varied sources, try to get all of your incoming fiat to route into your personal finance system via this checking account.

3. Fixed Costs + Debt Servicing

Next, create savings accounts specific to your big-ticket items. Think mortgage/rent, vehicle loans, other debt(s) such as student loans, credit cards, etc, utilities. These will mostly be your “fixed costs” of living + debt servicing.

You may end up with many different accounts, and that’s ok! In fact, that’s the point. As an example, after doing the above, you’ll likely see an account overview that looks something like this:

• Checking - Inbox
• Savings - Mortgage
• Savings - Student Loans
• Savings - Utilities
• Savings - Credit Cards

The next two steps requires us to create both push & pull aspects of the system. You want to push the right amount of funds to these new sub-accounts, while also creating automatic payments for your vendors who will then pull the correct amounts from these sub-accounts.

4. Start Your Funds Flow

What you want to do now is to create automated transfers FROM your checking account TO your sub-accounts for the amounts you will owe on that debt.

Checking -> Mortgage Savings

Checking -> Student Loans

Etc

For example, I have 2 automated transfers per month that moves 1/2 of the total monthly mortgage payment I owe from the Checking account to the Mortgage sub-account. I do this because I am paid twice per month, on the 1st and 15th.

To make it easy, let’s say I owe $1,000 per month. I pull 1/2 of the total ($500) on the 5th and 1/2 of the total (another $500) on the 20th. I leave a few days in-between when I receive my incoming funds and when I pull funds for these sub-accounts to give myself leeway if something stupid happened in-between. It’s usually a sign of being over-engineered when a system has no slack and can’t handle any deviations from the norm!

5. Automatic Payments For Sub-Accounts

Now that we have dedicated accounts that will always have the specific amounts of the debts we owe in them each month, we can set up automatic payments with your service providers from those dedicated accounts. We’ve already earmarked and set aside the fiat for the payments, so we can be sure that we’ll make our payments next month without issue. With the automated transfers, assuming you have enough incoming funds to cover your debts, you don’t even have to check!

The system will just run. Personal Finance Machine Go BRRRRRRR

6. Automated Transfers to Emergency Savings

After setting up your payments to your fixed costs and debts, you need to prioritize your own savings. Set up another savings account, name it “Emergency Savings”, and set up an automated transfer to it. You can always tweak the amount later to account for your real cash outflows, but I recommend starting at 10% of your incoming revenue and increasing that number over time as much as you can.

The biggest factor contributing to your ability to build wealth is your savings rate. It’s not your investment returns or your interest rates on savings accounts, it’s how much fiat you can save over long periods of time.

MAXIMIZE THIS.

I’ve worked hard to get my personal savings rate to around 35%. As I pay down more debt, I think I can lever that up to around 50% if I’m able to avoid buying a car over the next several years. Can you imagine keeping 35% of your paycheck?

How much easier could you breathe if, each paycheck, you went from keeping 5-10% of it to keeping 35% of it? How much faster could you build a 3-6 momth emergency fund? Pay down your home? Free yourself from debt slavery?

The rate at which you save is critical to your long-term financial health. I can’t make it any more plain than that. Act accordingly.

7. Accounts For Future Expenses

Now that we have our important bills and savings taken care of, you likely have future expenses you should be saving for. If you own a home, you should be putting money back for home maintenance items that will inevitably creep up. Water heater goes out, your A/C breaks, you develop a leak in the roof, etc.

These are all normal and expected things, so setting aside some money early to go towards these inevitable costs will save you a lot of worry in the future. Maybe you’re a renter, but you know you’ll need a new car in a few years. Whatever is the case, there are always expected future costs.

Save for them!

Decide when the likely time you’ll to buy the thing is (say, 3 years, 36 months from now). Figure out the total cost you’ll need to pay out of pocket when the time comes (say…$3,000 for home repairs).

$3,000/36 months = $83.34/month required to start saving now to completely cover those future costs. What should you do in order to handle this expected future cost?

Set up an automated transfer to a new savings account, “Home Repair”, for that amount each month! Now by the time you expect to need the money, assuming your situation stays relatively stable, you’ll have it (and you’ll have a lot less worry!)

8. Relax

The last, and final thing to do after following the above, is to relax a little.

Obviously there’s still the questions of investments, unexpected and weird personal situations you may be in, etc. This post is about the “Happy Path”, the generic system you can apply to your finances to reduce the amount of mental overhead you have to devote to managing your finances. For the personal finance questions that fall outside the scope of this post, take the Pareto distribution seriously, and identify the ways you can have a large, meaningful impact to both your finances and quality of life, and do those.

Don’t worry about ripping out every single percentage point of gain; unless it’s your damn hobby, the extra little bit you’ll earn will not be worth the extra effort on your part.

Hopefully, you already have a good relationship with money. If you don’t, well, here’s a few steps you can take to start working on it. I basically don’t have to check my finances at all unless there’s something unique happening with them (such as a new debt I need to service, paying off a debt so I can cancel that automated transfer and increase my automated transfers to my investment accounts, etc).

That is both financial and mental freedom! Creating systems that form positive-feedback loops like this one are some of the easiest bang-for-your-buck changes you can make. That’s true of personal finance, your health, your relationships, etc.

These types of systems you can create for yourself, and stick to, are extremely powerful. Make them work for you!

Until my next post…