Automate Your Finances
Setting and sticking to a budget is like making a New Year’s resolution knowing that you will break it one month into a new year (and believe me, this has happened to me far more often than I would care to admit). Luckily, budgets can be automated using technology, unlike sticking to a routine exercise schedule.
Through automating your finances, you are enabling your financial systems to work for you, rather than against you (See Note 1). After spending all of the effort up front to implement the systems, only minimal time is required to maintain existing systems of automation. All of the hard effort is made up front, much like how Michael Phelps spent most of his efforts early in his career to develop an athletic body, and now all he has to do is maintain it to perform at optimum levels.
Although few of us can aspire to build the same type of fitness level that Michael Phelps has, we can build a certain level of expertise in how we save and invest our money.
Set up an automated priority system for paying yourself first by saving and investing (See Note 2). This way, you will know exactly where your money is going and make it work for you, rather than letting money own you.
At a high level, put your paycheck into the following order (first complete one category before moving onto the next). Most of the following steps have options to set up a monthly autopay system, which means you only need to set it up once, and monitor it semi-regularly.
- Emergency Fund: In the case of a layoff, hefty medical bill, or other unknown event that will heavily impact your finances, you want to be prepared. Thus, building an emergency fund that will cover 3 to 6 months of living costs will protect you from unforeseen circumstances.
- 401k Employer Match: Many companies offer a percent that you will match you with on a 401k account, effectively doubling the returns on your retirement account.
- Debt and loans: Pay off all debts and loans, starting with the ones that have the highest interest rate. Another strategy is to pay off the smallest loans first in order to enjoy the feeling of a quick win.
- Roth IRA: For those earning less than 100k a year, a Roth IRA is an excellent choice for investments, since all taxes are incurred in the present, rather than in the future, when taxes will be much higher than they are today.
- Buy and Hold Diversified Index Funds: The stock market has averaged 8% growth since 1924, proving it to be a sound investment over the long term (See Note 3).
- Choose 3–7 Index funds that cover different sectors of the market to reduce risk while maintaining growth potential. These should ideally cover US domestic large-cap stocks (such as the Vanguard’s S&P500 index fund), US small-cap stocks, international stocks (both from emerging and developed markets), real estate investment trusts (REITs), and US treasury bonds. For an ideal bond to stock asset allocation, look at an age chart by a company such as Vanguard, T. Rowe Price, or Charles Schwab.
- Set up automatic regular contributions (such as monthly or biweekly) to your stock trading account. Some online brokerages allow your to also automatically adjust the percent that you contribute to each separate index fund. A great free mobile app for stock trading is Robinhood.
- Max out your 401k contribution: For those not seeking to launch their own businesses and more focused on saving for retirement, maxing out the 401k contribution based on your employer’s policies is the next best step.
- Pay off as much of your mortgage as possible. The sooner you get rid of existing mortgage loans, such as by paying more than necessary on a 30-year fixed mortgage loan, you are saving the interest that would be accumulated on it over the lifetime of the loan if you had not paid in advance. Paying for 100% down for mortgages is ideal, though not practical for many Americans.
- Deposit the rest into a savings account from your checking account.
- Save in advance for both expected (ex. Marriage ceremonies, your child’s college fund) and unexpected (ex. Medical bills from brain cancer) expenses. Automate expected contributions by counting back from the expected expense occurrence date. Even if you do not know how much your final contribution will be, you can use the average cost and ballpark the expense date (for example, the average age of marriage is 28 and the average cost of a wedding is $28,000, so if your are 26, then you should be saving over $1,000 a year if you plan on getting married. If $1,000 a month sounds too much for you, then even $200 a month is better than nothing).
- Many specialized savings funds are tax-free, such as a Education Savings Account (or ESA) for college tuitions and Medical Savings Account (or MSA) for patient care for the elderly (See Note 4).
- Fixed Living Expenses and (Budgeted) Fun: After paying yourself first, you can now pay your fixed living costs (i.e. rent, utilities, gas, groceries) and splurge on whatever you’d like, guilt-free.
- Live below your means and avoid keeping up appearances in order to appear wealthy (See Note 5).
- Be sure to budget and track general expense categories (ex. Food, transportation, entertainment), so that you can see how much you are spending each month on different expense categories. Budgeting sites such as Mint.com allow users to send automatic notifications whenever you go over the limit on one of these expense categories.
- I Will Teach You to be Rich by Ramit Sethi gives more details about setting up an automated financial system and specific recommendations for the best credit cards, savings accounts, and checking accounts.
- The benefits of paying yourself first is further discussed as through a set of parables in The Richest Man in Babylon by George Samuel Clason. In this book, many who fail to pay themselves first end up as slaves to their debtors.
- See A Random Walk Down Walk Street by Burton G. Malkiel and the work of John Bogle, founder of The Vanguard Group, for why index funds is the preferable method of long-term investing.
- The Total Money Makeover by Dave Ramsey gives more details about different types of specialized saving funds.
- The Millionaire Next Door by Thomas J. Stanley draws a key distinction between being wealthy and appearing wealthy, and why it is difficult to be both at the same time.