So you’ve decided to get your finances in order and live within your means. Your plan is to track your expenses, spend less than you take in and save for retirement, a rainy-day fund, your kids’ college education, a new car, down payment on a house, etc. The question is, how do implement your plan and adopt it into your everyday life?
Three Bank Accounts
Your spending throughout a year can be divided into three broad categories.
Everyday Spending includes groceries, gas, clothes, entertainment, small repairs and maintenance on your home and vehicle and anything else that usually varies month to month. You usually pay these expenses on a credit or debit card, or with check or cash.
A checking account can be set up to pay for these expenses directly or the credit card that they are charged on. An estimate of these expenses or desired budgeted amount per pay period should be funded each time you receive regular income from your job, small business, retirement distributions or other income. If you find you are constantly running on empty in the account, you are spending more than you planned.
Fixed Expenses include items that either don’t change or are within a predictable range each month such as your mortgage, utility bills, insurance, car payments and estimated taxes. College savings, IRA contributions and other investments should also be included. A second checking account should be set up to pay these types of expenses. Again, the account should be funded for the per pay period amount each time you receive regular income. Quarterly, semi-annual and annual expenses can also be paid from the account, just calculate the amount of these expenses per pay period and add to your funding. The balance in the account will build until these expenses are paid; if you pay your property taxes annually in November, you will be saving for them in this account all year with this method.
Savings should be accumulated in a money market account, short term CDs or both, but it is important to be able to access your cash quickly and that the value of this funding is not subject to the swings of the equity or debt markets. The balance of your income per pay period after you fund your spending and fixed expense checking accounts, irregular bonuses or other irregular or non-primary income should be used to fund this account. This is your “rainy day” fund which, in addition to job loss or large medical expenses, also includes the inevitable new air conditioning for your car, hot water heater or other large unpredictable obligation. You can also build up these funds to save for predictable items as well such as a new roof, down payment for a house or a new car.
Execution by Habit
Write down how much per paycheck, draw, retirement distribution, etc., should be transferred to your spending, fixed expense and savings accounts. Hold these accounts with one or two financial institutions and make sure you can easily transfer funds from the account your paycheck is deposited into to the three accounts. If your regular income is variable, fully fund your fixed account first, then your spending account and finally, your savings account and adjust your spending accordingly. Once you get everything set up, the process becomes second nature, you get paid, you transfer the funds and, as long as you estimated your expenses correctly everything runs smoothly. Consider evaluating each fund’s expenditures at least a few times a year or when something big changes so you keep your plan current. Once your new plan runs like a well oiled machine you’ll spend less time thinking about your finances.