[Editor's Note: The following guest post was submitted by Tim Quillin, CFA and Partner in Aptus Financial. Aptus is a flat-fee hourly financial advising firm that is a WCI advertiser and on our list of recommended advisors. This is not a sponsored post.]
Financial success hinges on one critical concept: spending less money than you make. For those of you lucky enough to be natural savers, this is intuitive and relatively effortless. For many people, though, even high-income physicians, this is often much easier said than done. If you buy the big house, drive the Model S, send the kids to private schools and make the minimum payments on your student loans, you may never save enough money to retire comfortably.
Over the past 12 months, I’ve worked with a single-income family making $160,000 with $175,000 in student loans. They needed a system. But I’ve also worked with a dual-income family making $750,000 a year who were deep in credit card debt and barely saving 5% of their gross pay. They needed a system as well.
Save More and Live Better — Put Your Money on Autopilot
An automated cash flow system can take a lot of the drama out of managing your money. A good cash flow system should help you determine the best balance of spending in ways that make you happy, bring you peace of mind and express your values while also paying off debt, saving for known and unknown future expenses and building a retirement nest egg.
Automated Cash Flow System
After implementing an automated cash flow system, the $160,000 income family implemented an automated plan to pay off debt in 7 years. The $750,000 income family increased its savings rate from 5% to nearly 30%, putting them in position to retire in their 50s.
An automated cash flow system should include 4 basic steps:
#1 Pay Yourself First
Pay yourself through payroll deductions into company retirement plans, automatic drafts toward debt repayments and consistent, automatic investments into IRAs, HSAs, and other investment accounts. For high-income physicians, the goal is to direct 20%-40% of gross pay into student loan reduction or retirement investments before you even see your take-home pay. Live on 60%-80% of your gross pay while you build net worth for the future.
#2 Set Aside Money for Future Expenses
Do this by auto-transferring fixed amounts each month into individual, named savings accounts. For instance, you might set up individual high-yield savings accounts for emergencies, home repairs, car purchases, out-of-pocket healthcare costs—especially if you use an HSA for retirement savings—and vacations. You can use a 529 plan to save for your kids’ college tuition. You should proactively save for any known future expense, even if the timing is uncertain. While some people prefer a single emergency fund for their savings, it’s often psychologically satisfying to have discrete pools of cash so there’s clarity on how the money is to be spent.
#3 Pay Your Monthly Bills
This is done typically through auto-drafts. Carefully accounting for all your bills provides an opportunity to eliminate or reduce expenses when feasible. Continually validate your term life and disability insurance needs and periodically get competitive quotes for home, auto and umbrella. Pay especially close attention to recurring monthly subscriptions, which often slip off our radar. Don’t pay for a newspaper you don’t read or a streaming service you don’t watch.
#4 Spend the Rest
After you’ve 1) paid yourself first, 2) set aside money for future expenses and 3) paid your bills, you simply spend the remainder of your income. There are essentially three ways to spend the rest. You can use a credit card, but you can easily overspend. You can use actual cash, but this can be unwieldy. If you want some degree of self-regulation, though, you can set up a second checking account and spend with a debit card.
Self-Regulation With a Debit Card
Here’s how it would work. Take your monthly remainder, multiply by 12 and divide by 52 to arrive at a weekly amount you will deposit into a 2nd checking account. Set up a weekly auto-transfer into the 2nd checking account each Monday, as it’s easier to plan your expenditures over 7 days than 31 days. Then use debit cards to spend your weekly allotment. You won’t overspend because you can’t overspend.
The Problem With Credit Cards
Many folks use credit cards prudently and accumulate rewards while staying within their budget. They pay off their credit cards in full each month and go on vacations with their reward points. The academic evidence is strong, though, that people are inclined to spend more—perhaps a lot more—when using credit cards rather than cash. So even people who use credit cards responsibly might end up spending more than they would with cash or debit cards. The 1%-2% you get back in rewards doesn’t seem worth it if you spend 10% more than you would without the credit card.
It really doesn’t matter precisely how you automate. If you are a W-2 employee, the automated flow might look something like this:
It’s not always that easy, especially when your income is highly variable. If your income is less consistent, then you might adjust the flow slightly:
There are dozens of ways to customize an automated cash flow system to fit your specific circumstances and behavioral psychology. The important concept is to set things up on autopilot, so you don’t have to decide every month how much to save.
If you do nothing except pay yourself first, you could still end up having enough money to retire but may bounce in and out of debt due to one financial “emergency” after another. If you also set money aside for future expenses, you should be financially healthy. If you optimize your spending across all four steps, a cash flow system can provide peace of mind, happiness and freedom.
You will slay debt, build wealth and laugh in the face of typical budget busters. The roof leaks. No worries, you have a home repair fund. The car breaks down. No problem, you’ve been saving for a new one anyway. You need a little time to recharge. Time to use your vacation fund for a trip to Italy this summer. Your job’s becoming an unbearable grind. That’s ok, your emergency fund is an FU fund to help you start your own practice.
Make sure the cash flow system reflects your priorities and values. Failing to pay attention to your priorities and values may quickly derail your plan. Ultimately, you will need to strike a balance between your lifestyle and your need for financial security. Don’t underestimate the thinking and deliberating it may take to reach that balance. But, once you have made your decision and implemented the automated cash flow system that works optimally for you and your family, you will never look back.
Have you set up an automated cash flow system? How have you customized it to fit your specific needs? How has it worked for you? Comment below!