Personal finance in 7 steps

A friend asked recently how I manage my “emergency fund.” Sitting down to write my response, I realized I had never put my personal financial structure down on paper.

This is an attempt to do so. The following 7 steps represent the basic structure I’ve set up for my personal finances.

These steps (or layers) are listed basically from short to long-term consideration. Think of them as a sort of waterfall: fund 1, extra goes to 2, fund 2, extra goes to 3, and so on.

  1. Checking Account (Primary liquidity) — Contains only the cash I’m budgeted to use for one month; all after-tax income gets deposited here and subsequently transferred out depending on its use.
  2. Savings Account A (Emergency liquidity) — Contains some cash to serve as a buffer in case there is a significant unbudgeted expense in any given month (e.g., car repair).
  3. Emergency Fund (Low risk investment; unknown time horizon) — Contains an amount equal to six months of expenses in case of job loss; currently invested in a diversified bond ETF (Symbol AGG^ — Low volatility; ~2–3% interest) that presents minimal risk to the principal but an attractive interest rate compared to a savings account.
  4. Savings Account B (Mid-term expenses) — Serves as a savings vehicle for mid-term budgeted expenses (e.g., annual vacations, home/car down payment, etc)
  5. Retirement 401(k) (Primary retirement fund) — Assuming funds 2, 3, and 4 are full, all of my savings goes to this account until I’ve reached the annual contribution limit.
  6. Retirement IRA (Secondary retirement fund) — If I reach the annual 401(k) contribution limit, any additional funds go into a traditional or Roth IRA up to the annual contribution limit.
  7. Brokerage Account (Non-tax incentivized investment fund*) — If I reach the annual IRA contribution limit, any additional funds go into a brokerage account and are invested in a diversified portfolio with a long-term orientation.
  8. Other Considerations — To the extent possible, I run all my monthly expenses through a credit card with generous cash back (1.5–2% seems to be the best overall) and pay it off in full every month. Also, if I’ve managed to fund accounts up to #7, then I would fund #7 only if I felt that an investment portfolio would, in the mid-term, realize returns higher than the interest rate I’m paying on student debt; if I felt it wouldn’t, then I would make prepayments on my student debt.

This is simply what I’ve come up with on my own. I’m always open to new, better ideas.

^Any diversified, low cost bond fund would do. This one is the best option for me simply because my brokerage allows me to trade in/out of it commission free, so I don’t have to worry about trade commissions eating at my savings.

*If I have enough money to get to #7, then I start to consider funds 5, 6, and 7 as a single diversified portfolio. There is a tax advantage to having dividend paying investments (e.g., bonds) in tax deferred accounts and investments with low dividends but capital gain potential (e.g., most stocks) in taxable accounts. So at this point I would start shifting most of my bond investments to the 401(k) / IRA and my stock investments to the brokerage account.

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