For the past few months, I've been moving toward a system of paperless personal finance. In this guest post from Paul Lussier, he explains his own automated system.
Lately J.D. has been talking a lot about automating his finances. In my world (that of high-tech, software, and large computer systems), we strive to automate as much as possible. By doing this, we hope to minimize error by reducing human interaction, leveraging the power of the computer for what it's good at, leveraging the power of people for what we're good at.
In other words, we emphasize the strengths of both the computer and the human. Computers are really good at doing the tedious, mind-numbing, soul-sucking repetitive tasks which humans hate. Humans are far better at reasoning, logic, and creative thinking than computers.
I've applied this understanding to put my finances on auto-pilot. I use the automated computer systems at my bank to move money around between different accounts, pay bills, earn interest, credit-card points, etc. Though the following system may seem complex, it's really fairly simple once it's set up. (This method also works nicely with the recent post about building wealth with a “virtual employer”.) Here's how my system works:
Consolidate your bank accounts
I've consolidated all my accounts at USAA Federal Savings Bank. Their online banking site and customer service are unparalleled. Choose a bank with which you are comfortable, and which does not charge outrageous fees or otherwise “nickel & dime” you to death.
If you use credit cards, get a credit card with this bank and stop using the others. If your bank and credit card are with the same institution, you can easily set up automated payments from your checking/savings accounts to your credit card to occur on the due date. This will virtually eliminate all late fees! Consolidating bank accounts makes life simpler.
Set up overdraft protection
Some banks allow this — others don't. My bank does. Using your savings account to protect your checking account does mean that you may lose some interest on your savings. But it's better than having to pay back the overdraft amount plus interest, plus a possible late/finance charge on top of that. In some cases you can set up a credit card to be the overdraft protection, but this just feels wrong to me.
Set up accounts specifically for bills
This means you actually have two checking and two savings accounts. One pair is for Daily Use — this checking account is the one from which you buy gas, groceries, take out cash at the ATM, etc. This primary savings account is where you stick “extra money” (more on that later).
The Bills accounts are where you start budgeting. I struck on this idea when we had some major financial re-organization a year or so ago. I opened a new savings account online. The process took five minutes. I calculated what our bills cost, and then set up an automatic transfer from my Daily Use checking account to the Bills savings account to occur on the dates when I get paid. Now I'm budgeting this way for all my bills that occur less than monthly, and I'm earning ~4-5% interest on the money as well!
Sign up for direct deposit
Have your check directly deposited to your Daily Use checking account. In most cases, that money is available one business day before payday. Compare that with the hassle of having to go to the bank, deposit the check, and have it clear. That whole process, if you're lucky, takes two days, which means it takes three days longer than with direct deposit. Think of the amount of interest you're losing and the amount of time required to go to the bank!
Pay yourself first
For many people, paying yourself first is the starting step. But with this system, you need to set up the infrastructure to handle paying yourself first. Set up an automatic transfer from your Daily Use checking account to your Daily Use savings account on each day you get paid. It doesn't need to be big: $10/week, $100/month, $50/paycheck — whatever you think you can afford. Remember, if you need this money, it's just a transfer away. But the key is to make it more painful to get at.
Pay your bills second — automatically
Now that you've set up the infrastructure, determine which bills you want to budget for. Set up an automatic transfer for that amount from your Daily Use checking account to your Bills savings account on the day you get paid. (You're moving the money to savings because it will earn a higher interest rate than in a checking account.) Consider putting it in a certificate of deposit which may earn a higher interest rate.
I pay my bills with debit and credit cards, and sometimes with my bank's automated bill-payment system. (Different vendors have different requirements.) Again, this allows me to consolidate things. Looking at my credit card statement, I can see most of my bills in one place. Also, I don't have to worry about variable payments. For example, my cell phone bill fluctuates from month-to-month based on usage, text messages, etc. This makes it difficult to set up an automated payment from my bank. Charging the bill to my credit card solves this problem.
If you have a Bills checking account, you can use the associated debit card to pay bills, too. I use the credit card, since my rewards credit card provides me twice the return compared to the rewards debit card. Using the credit card also provides me with some amount of protection in the case of identity theft.
Schedule recurring transfers
Now that all your accounts are in place, it's simply a matter of setting up transfers for the correct times and amounts from your Bills savings account to your Bills checking account. Though this may sound complicated, it's not.
It's true that the process of transferring between all these accounts works best when the bills are large and infrequent. For example, I have a variety of insurance bills, none of which occur more often than quarterly. By totaling all these different bills, I'm able to use this system to not only budget these expenses, but also earmark certain monies specifically for them all while earning interest on them.
For regularly occurring monthly expenses (like electric, cable, cell phone, etc.), I have the biller charge my credit card. This makes sure the payment is never late and earns me a bonus reward. The credit card bill itself usually gets paid directly out my normal checking account because that's where the money happens to be.
Another thing I like about the separate checking/savings account set up is that if there are billers who need to draft a checking/savings account, I can completely isolate what they have access to. I can also make sure that the money is sitting in savings until the last possible moment but gets automatically transferred over in time to pay the bill without incurring a late fee.
Putting the system into practice
This is my first year using this set up. So far I like it. As I continue to refine and tweak it, however, I'm finding a few rough edges. For example, I can schedule an automatic bill pay for an indefinite amount of time in the future, but I cannot schedule a transfer between savings and checking to occur on a date greater than one year from today's date.
Also, the scheduling of automated transfers is not as granular as with the automated bill pay system. I can set up transfers to occur weekly, 1st and 15th of the month, every two weeks, every month, or every two months. I'd really like to be able to set up a transfer for the 15th and last day of the month (when I get paid) and I'd really like to set up transfers every three months (quarterly) on a given date.
I hope you find this system useful as I have!
Thanks, Paul. I, too, continue to refine my paperless personal finance system. It's a matter of discovering which accounts work best with which companies. Sometime later in 2008, I'll describe my current setup.
Final note: Paul sent me an e-mail the other day. “Ironically,” he said, “I just finished The Automatic Millionaire. It was great read. I was amused to read so much of what I already do on my own. Most of what I do here is covered in much greater detail in that book.”