As part of the ongoing simplification & optimization of my personal finances, I’ve made some changes to how I route money between my various accounts. But I thought it’d be worth looking at how I arrived at my individual solution, starting at the beginning, some 16 years ago.
Please keep in mind that this is what works for me personally; I’m not suggesting this is the best way to organize accounts. It makes sense to me but then I’m a software engineer. At the end of the day, any account structure you use has to be as easy and automatic as possible and it should support your savings and investing goals.
It started with a checking account
When I first arrived in the US, I opened a checking account at a regular brick & mortar bank. I think they even paid interest back then. I had the simplest structure possible as shown below.
I was paid with a check every 2 weeks which had to be manually deposited (although over time it eventually became a direct deposit). From this one account I paid bills and made purchases with a combination of cash, checks and credit cards.
I was generally earning more than I was spending so any remainder left over at the end of the month just stayed in the account, gradually increasing the balance.
Saving more effectively
Eventually interest rates all but disappeared and so I added a Savings Account to the mix; initially with the brick and mortar bank but later I moved to an online account for a 1% yield.
I spent pretty much whatever I wanted to at this stage of my financial journey (somewhere up until 2009). I just moved money that I declared surplus at the end of the month over to Savings and tried to avoid moving it back to my checking account the next month!
Spending was still direct from my checking account, with automatic payments to pay off the balance in full each month.
In case of emergency, break glass
Eventually I added a separate account to hold my Emergency Fund. This was held in another online savings account.
It was easy to set up an automatic payment to pay into the EF account each month. So as income came in, some would go to the EF, any checks / credit card balances would be paid and finally any left-over money went into Savings.
Learning to budget
At some point around 2010 or so; I opened an online checking account which offered Bill Pay. It also offered a pretty good interest rate; much better than the 0.01% in my main checking account.
So my Living Expenses account was formed, and this slowly moved me into a more formal budget. I could reduce the amount of money held at 0.01% in my main Checking account, and build up a 3-month buffer of expenses in my Living Expenses account. All credit card charges, checks etc. were linked to this account with automatic payments as before.
And since my budget is constant; new money added to the Living Expenses account was another automated monthly transfer after the Emergency Fund contributions.
Enter the Income Fund
Saving is great, but in my case I was building up a lot of cash that was just sitting there and I didn’t really have any particular purpose for it. Now I know that’s a fantastic problem to have – my solution was to start investing in 2011.
The above structure is pretty much what I have today. The EF, Savings and Budget payments are all automated, but there are manual transactions for moving money into the Income Fund since the monthly remainder amount is variable.
And until recently, I’ve been moving dividend income back into my Checking account each month as I’ve always viewed it as a surrogate Salary. The money ended up back into the Income Fund anyway since the higher income resulted in a higher remainder, but this mechanism provided more flexibility into which brokerage to direct the money into.
But all the manual transactions going back and forth were still a pain to deal with.
Thinking about the future
To simplify the account structure and reduce the amount of manual transactions that I need to make, I’ve decided to start automatically transfering $300 a month from the money market account in my Income Fund to my Living Expenses account. I’ve also reduced the automated transfer from my Checking account to my Living Expenses account to $3,600.
With this approach, my Living Expenses account still receives the Budgeted amount of $3,900 monthly without any involvement on my part. And it means that I can transfer $300 more from my Checking account to the Income Fund each month. Money is fungible so all dividends are being reinvested in that sense.Now my Income Fund should pay over $7,000 in dividends this year, so in theory I could withdraw $600 or so a month. But my plan is to pay all dividends into my money market account during the year (less $300 a month). At the start of next year, I’ll pay out the prior year balance in 12 equal payments; essentially keeping one year’s worth of dividends as a cash-buffer. I picked a smaller amount so I can start building up this buffer.
So assuming I receive $7,000 total dividends this year then at the end of the year I’ll have $4,000 left. So 2017’s distribution would be $4000 / 12 = $333 a month. And the distribution in 2018 would be the full 2017 dividend amount / 12.
There is a cash-drag effect for doing this since the cash component will end up being a portion of the Income Fund equal to the dividend yield. I may also reduce the buffer size over time as income increases. But since the payments reduce the burden on my salary, I still get to invest that amount extra each month in any case.
Although it looks like a fairly minor change; it has a number of benefits:
I can automate most of the money transfer from my Checking account to the Income Fund (and to the money market fund specifically), since there’s only a small variation in my salary income. So it’s not a big deal if I forget to manually transfer the remainder in a month.
I can automate most of the monthly purchases inside my Income Fund with automatic exchanges from the money market account. Manual transactions are only needed for stock purchases or for rebalancing.
Looking to the future
Eventually I’d like to retire my Emergency Fund completely. And on finally retiring I also wouldn’t have a salary. So the long-term goal would likely simplify things further, something like:
I’m not sure what kind of Savings Plan I would need at that point, but I assume I’d need something e.g. for unexpected medical expenses, or house repairs. My 401k and IRA accounts also need to be considered too but that’s a problem for another day (or decade).
I realize that I could simply re-invest dividends in my Income Fund and keep it entirely separate from my main accounts. But I look at this as practicing for FIRE and learning how to manage distributions from my investments as I wean off my salary. I want a system that requires monitoring rather than active managing and one that I’m familiar with when I finally retire.
Quote of the Day
A bank is a place that will lend you money if you can prove that you don’t need it.