Photo By: Pietro De Grandi

Typically when you meet with a financial advisor/planner, they will ask you, What are your goals?

Why?

Because it helps in the development of a plan based around making intentional decisions directed toward a well-defined goal. This goal usually takes the form of a retirement age; there’s an entire movement called the FIRE (Financial Independence Retire Early) based around determining your basic annual living expenses amount and then determining your FIRE number which is typically the invested sum of money that will allow you to live off of the returns and dividends at a specific withdrawal rate (a percentage of 4% typically) to stay within that annual living expenses limit (i.e., passive income). The entire concept rests on primarily living frugally enough while producing enough income to invest or save the largest amount in anticipation for this goal.

I’ll be honest. I do not have a strict retirement goal. I appreciate the focus on freedom behind many aspects of the FIRE movement, however I do not share the same effects of work burnout that makes the Retirement Early aspect of the movement so appealing to so many. Because of this uncertainty concerning my own goals, I rather focus on building a system in place to most effectively handle my financial concerns; therefore here’s an outline of my current system.

Spending Strategies

I covered this fairly well in my previous post How I Learned to Stop Worrying and Love the Credit Card, but to revisit and summarize that post; I essentially move all expenses that do not include a “convenience fee/percentage” through a specified credit card based on the category of that expense. All scheduled payments are automated either as credit card charges or ACH withdrawals (once again based on the absence or presence of a “convenience fee”). All statement balances are paid in full each month to ensure that no finance charges or interest charges are incurred.

One thing that I did not cover is that in relationship to my checking account, I will use the credit union’s credit card as my “all purpose” card until the interest tier’s required spending amount is met.

Scenario A:

If I spent $1000 on my all-purpose card, 1.5% or 2.0% cashback. This would result in a cashback rewards amount of: $15 - $20.

Scenario B:

However, if I spent $1000 on my credit union’s card, 1.0%, this would result in a cashback rewards amount of: $10. Either $5 or $10 less than if I were to do the same with the other card. However, this would unlock the 5.09% APY interest tier in the Checking Account for a balance up to $10,000 which would result in an interest amount of ~$41.

Therefore…

Scenario A: $15-$20 Scenario B: ~$51

This is even being generous to Scenario A since the majority of the $1000 required spending amount on the credit union’s credit card will largely be Groceries or Gas purchases where the credit union’s credit card’s rewards would be equal to or greater than those of the all-purpose card.

This strategy has served me fairly well. I simply use Mint.com as my primary budgeting software to monitor my spending habits by linking my individual financial accounts to the software and re-categorizing if necessary. Therefore all that I’m concerned with on a monthly basis is the presence of a margin (i.e., profit) and how to treat this margin. Which brings me to my next point.

Saving Strategies

First, I try to meet the employee’s matching contribution amount for any provided 401k/403b plans.

Now assuming that I have a positive cash flow for the month. How do I treat this margin of money?

Well, I have what I would call my Cash Buffer. This would be my checking account detailed in Why I Left My Regional Bank. All transactions initially interact with this account, this includes any income (direct deposits) and also any expenses (primarily ACH withdrawals and credit card payments). The goal is to keep this account balance right above the balance that earns interest (e.g., $10,000).

After each month, based upon my spending and income, I will take one of the following approaches:

1. If the account balance is less than or equal to $10,000 (or whatever the interest earning balance is), I will simply do nothing. I will want to allow the Cash Buffer to recover and fill back up to this balance amount.
2. If the account balance is greater than $10,000 (or whatever the interest earning balance is), I will anticipate any early month ACH withdrawals and take the difference between the current balance and the $10,000 plus early withdrawals amount. This ensures that once the early ACH hits, it won’t drop the remaining balance below $10,000. This resulting difference is the margin.

If all goes well, this Cash Buffer will earn 5.09% APY up to $10,000.

Now that I have a margin, I will move this amount to my savings account also detailed in Why I Left My Regional Bank. This what I would call my Staging Account and it consists of two primary parts:

• The Emergency Fund (3 or 6 Months of monthly expenses)
• Short-Term Savings

My primary concern first is to fill up this account to the amount determined by three months of monthly expenses which can quickly be calculated by simply adding up your monthly scheduled payments, your semi-annual expenses total divided by six, and your annual expenses total divided by twelve. Barring a complete catastrophe, this account should always have three months of expenses.

If I add any new scheduled payments, I would need to adjust this amount accordingly.

This account will earn 2.20% APY up to $250,000 (the FDIC insured amount).

The amount above this three month of expenses total falls into the category of Short-Term Savings which are no risk savings for the purpose of being used in a short time frame.

What are some of these uses?

• Saving for the down-payment on something (e.g., house, car) or some large purchase or payment.
• Lump-Sum Investment in one of the Tax-Advantaged Investment Accounts

The second choice brings me to the last buckets, the Tax Advantaged Investment Accounts.

These include:

• The Roth IRA.
• The Health Savings Account
• The 529 Plan

All of the investments in these accounts grow tax-free. The Roth IRA is a post-tax account whereas a Traditional IRA is a pre-tax account but they share the same annual contribution limit. Also, despite being a last resort, you can withdraw your contribution amount from your Roth IRA. There is also an income limit to contributing to an IRA. The Health Savings Account (HSA) requires a high deductible health insurance plan. However, the HSA is described as a triple-advantaged account, you can contribute pre-tax, your investments grow tax free, and you can withdraw the money tax-free as long as you’re reimbursing yourself for prior qualified medical expenses.

The 529 account is a post tax account that grows tax free, however, it is to be used for educational-related expenses and has an unspecified annual contribution limit. Therefore, the contribution limit to this account is the discretion of the contributor. However, if you contribute more than the annual gift tax amount (i.e., $14,000), you would need to report the difference on an annual gift tax return since it is categorized as a taxable gift.

There are two ways of contributing to these accounts:

• A lump-sum contribution of the annual limit of the account. The advantage being that more time in the market equals better long term returns. The disadvantage being the short-term losses if you were to contribute and buy at a peak.
• Dollar-cost averaging. The advantage being that you can effectively ride the short-term waves of the market and thus buy at a discount on worse performing months. The disadvantage being less time in the market overall.

How I invest within these accounts is critical to the effectiveness of these accounts. For HSAs, and 529s, you’re more limited to the custodian’s fund choices and possibly even your employer’s choice of the custodian (similar to your 401k).

With the Roth IRA, I have more freedom by keeping the accounts at Vanguard and investing in low fee index ETFs (exchange traded funds) provided by Vanguard. Being young and also trying to keep a healthy percentage of my asset allocation in Cash, I invest strictly in Equities using the asset allocation breakdown below overall.

• 50% Large Cap/S&P 500
• 20% Mid-Cap
• 20% Low-Cap
• 5% Emerging Markets
• 5% Sector-Based

Is this a definitive asset allocation for everyone? Not at all. It works for me however. I try to keep the invested percentage in an inverse relationship to the volatility of the investment. Notice how there is none invested in bonds. I rather keep a fairly large percentage of my overall asset allocation in cash.

Also, these are long-term investments. I simply invest and let sit only to re-balance annually if necessary.

Now, if I have met the contribution limits for all of the tax-advantage accounts including the 401k/403b’s annual contribution limit (if provided by the employer). I return to the Staging Account from above and begin working on increasing the emergency fund to six months rather than three months.

Once that goal has been met, I can do the following:

• Open a non-tax advantaged brokerage account and begin investing in that account.
• If a large purchase is on the horizon (i.e., down payment on an investment property), I simply keep accruing money in anticipation for this purchase.

Now throwing debt into the equation. How to prioritize paying off the principal amount of outlying debt.

Many people recommend comparing the interest rate of your debt and the potential interest rate of the returns that you would receive if you used the money differently and choosing the larger of the two. In an ideal world, I would try to keep the Cash Buffer untainted as well as the three months Emergency Fund then use the extra in that Staging Account to save for a large principal payment on the outlying debt.

Some would rightly argue that this choice could impair contributions to your tax-advantage accounts or if nothing else significantly reduce the time in market. This is fair and something I would need to take into consideration. Also to be taken into consideration is the freed up cash flow from paying off the outlying debt. I explored these trade offs in at the conclusion of my post, Was Paying Off My Car Worth It?.

Altruistic spending…

After each month, I take 10% of my net income for that month and distribute it to various charitable organizations or personal causes as necessary. I keep these organizations listed in a spreadsheet and generally round up to the nearest dollar when calculating the contribution amount.

If this 10% exceeds the margin for that month, I do not let this affect the contribution amount. However, I would need to re-evaluate my spending to ensure that this doesn’t occur in subsequent months. In an ideal world, your cash flow should be such that you can afford a 10% of net income charitable contribution expense as well as having plenty left over to fund your other accounts (or buckets).

In conclusion, these are my spending and savings strategies. They are largely goal-agnostic but could be tweaked and modified to fit most goals.