I was telling a friend about some bad luck we had the other day which ended up as an unexpected expense. He was sympathetic and commented that it must have been the last thing we would want coming into Christmas with all the extra costs. I had to agree with him, no one likes the added expense, but it actually didn’t hurt as much as it could have.
Last week we were unfortunate enough to pick up a big screw in one of our car tyres. I’m still not sure how it managed to occur, but it needed some pretty quick attention so my family and I jumped into the car (the tyer was still inflated) and drove down the street to the tyre shop, which for my wife was conveniently located next to the shopping centre.
A quick check by the tyre mechanic revealed that it was not salvageable. Pretty disappointing as it was only about a year old and otherwise in good shape. Luckily for me they decided to do a deal on the replacement, but it still ended up costing almost $200.
Emergency Fund on Tap
I explained to my friend that we have separate accounts that we use to save for different things, one of which is an emergency fund. It’s a very simple system (like an electronic envelope system), but it means that we never get caught out. He thought it sounded like a pretty good idea, so I gave him a quick run down on the way we handle our money.
Generally I like to try and avoid the word budget as it often conjures up bad mental images for a lot of people and they just stop listening immediately. Saying you have an automated system with separate accounts that your money goes into is the best way to combat this, it makes people think the idea is a bit different. Occasionally you get a clever person asking if it would be better to put all your money into a mortgage offset account, but for simplicity and the small difference it makes, I like this system better. I have covered this before here on the site, but I know so few people that actually do it, I’m going to cover it again.
The Money You Keep
This is an important wealth creation rule. The amount you keep (to invest and never spend) should be as much as you can afford, but go for 10% of your income as a minimum. Treat this as a bill that you can’t ignore and pay it first. The best way to do this is to set up a savings account called Don’t touch (or whatever you want really) for this to go into. A savings maximiser account with ING Direct is perfect for this (the US version is here). Later, when you have a nice stash, you can look at ways to get it working hard for you, but if you are just starting out, just set it up and forget about it.
You should be able to get a total for all of these from old bills or looking back over a bank statement, then put away an appropriate amount every time you are paid (review it occasionally when you are feeling super productive). Use another savings account – either ING Direct or you normal banking institution (if they don’t charge fees) – and call it the Bills Account. So now when the bills roll in, you have the money ready to pay them without even thinking about where you are going to find it.
This is not money you keep, it is money you spend on all the stuff you want. It might also include a Christmas savings plan and should absolutely include an emergency fund. Your emergency fund should be at least 4 weeks pay and preferably more, but you can work up to that. Try and get to at least $500 as quickly as you can so you have a buffer for emergencies, like new tyres for the car.
If you are really bad with money, then you might like to create separate accounts (e.g. holiday, emergency fund and Christmas savings). In fact, it isn’t a bad idea to have a separate account for any significant savings goals that you have – think new car, kids education etc.
Food and Pocket Money
These are regular expenses which should be paid from your everyday account. Use your credit card to buy food and petrol to get rewards if you are strict and if you can pay it off in full before the end of the month. If not get rid of the credit card and use a debit card or just take the money out of the bank. Knowing exactly what you have to spend is the simplest way imaginable to avoid over-spending.
Get Someone Else To Do The Work
There are two ways to ensure your money gets split into the different accounts you set up:
- Set up a direct debit from your everyday account for the day and frequency you are paid. The money left in there after the transfers is yours to spend on whatever you want.
- Get your employer to divide your pay into your separate accounts. They may moan and groan, but if you give them all the details (account details and amounts), it really isn’t that hard and they only need to do it once.
Option 2 is a safer option if you think you might dip into your accounts. In this case definitely don’t get a credit card and use ING Direct, as you need to transfer the money back out and wait 24hrs before you can access it – this gives you time to feel guilty and will reduce the likelihood of impulse spending.
I don’t know if my friend will implement any of this, but I think that it is a really simple plan worth sharing with those who aren’t familiar with it. Do you have any foolproof emergency fund or money management systems that you use?
Image by kayaker1204