I remember feeling quite chuffed with myself when I worked out this little money management system. I was in my early 20s and just started my first real job out of uni. Going from a uni student to a full time worker meant a massive increase in my pay.
I came up with this system probably because I was overwhelmed with the extra money I had. Going from $400 per week to $900 per week was huge! I remember thinking at the time that I had survived living on just the $400 per week for 4 years so I wouldn’t need a lot more than that and anything left over I would just save.
But as you get older your expenses tend to increase. Some expenses are unavoidable and some a little self-indulgent but understandable. Things like renting a nicer place or going onto your own mobile phone plan. I realised that I had a few different expenses to take care of.
There were predictable expenses like rent, gym membership and groceries. Others like electricity, fuel and entertainment were a bit more random. I had savings that I wanted to build and everyday expenses like buying a coffee or catching public transport.
So I put together an automated system that would meet all my financial obligations and I wouldn’t have to manually pay bills every month. It was all done for me. This system is what I want to share with you today.
Since I first put this into place I have found that I was not the first person to do this. It is a very common money management practice used by rich people. Or at least people who were on top of their finances.
The foundation of the system is the same for most but as individuals we like to put our own little spin on things to suit our personality. This should be no different.
It’s so easy to become overwhelmed with finances. Retirement plans were introduced as individuals were such bad savers the burden on the government was too much to continue funding people’s pensions.
But even retirement plans won’t be enough to live off when you stop working. You need to save more. And then invest more. An automated money system will allow you to save money, pay the bills and still enjoy your hard earnt cash without looking in dismay at your bank account every month.
In Australia your employer has to pay 9.5% of your wages to your superannuation. You never see this money as it goes directly to your super fund. It’s a great wealth building tool as it is tax effective and takes advantage of compound returns.
Below is chart based on a 25 year old who aims to retire at 67. If they have a wage of $65,000 for their life with 9.5% contributions they could have a balance close to $600,000 when they retire. This is based on an annual return of 8%.
What to do
Get familiar with your retirement fund. In Australia you can log in and choose your investment strategy. The default will see your super 50% in cash and 50% on property and shares.
If you think that shares will perform well you can change to 100% shares. If you are nervous about both shares and property you can go 100% in cash. It really depends upon your risk profile and age.
Also keep track of return your super is providing particularly in relation to fees. Everyone focuses on lower fees but this is not always the best outcome. Which option would you prefer?
Option A – Return 6%: Fees: 0.5% Total Return: 5.5%
Option B – Return 9%: Fees 2.5% Total Return: 6.5%
Reviewing your super 1 to 2 times per year should be enough. Again depending on your age.
Chart from www.moneysmart.gov.au
Think of this as short term and emergency savings. Holidays, weddings or a house deposit are prime examples. The money will eventually be spent.
What to do
Set up a high interest savings account that does not come with an ATM card. By not having an ATM card you are less likely to engage in impulsive spending as you don’t always have access.
You will still have all the benefit of online banking and transfer etc but it will be a bit of ‘out of site out of mind’. Ideally you’ll also want an account that has no banking fees. Arrange with your employer about having a portion of your pay going into this bank account.
An old school investment mantra is to ‘pay yourself first’. And this amount appears to be a minimum of 10%. You can add more if you have little debt or living expenses. The aim here is to save enough to invest. Perhaps you will save $1,000 and look into buying a parcel of shares.
Or buy units in a Real Estate Investment Trust (REIT). The basic aim of investing is to at the bare minimum outperform inflation. With inflation being between 2-3% over the long term, this is the minimum return you want on your investment so it will uphold the value of your money.
Below is the long term average return of the various asset classes over a long period of time. As with above arrange it with your employer to have this percentage of your pay going directly to your account.
Source – IRESS and MVM Research, November 2014
*Past performance is not a reliable indicator of future performance. This table is only intended for information purposes only. It is not intended to provide financial advice. You should consult your appropriate financial professional to consider the appropriate of any investment appropriateness.
What to do
Open another savings account with similar features to above. Again watch the fees and try to get them as low as possible. Start to think about what type of investments best suit your needs. Things like a managed fund may be a good place to start as it gives you access to assets with a smaller investment.
A managed fund is very similar to your superannuation or retirement fund. Watch out for the fees, look for the overall performance and check what the fund Is actually invest in.
Below is a chart based on someone investing $400 per month for 10 years with a return of 9% per year. The end result is nearly $73,000. With $48,000 of your own money and around $25,000 from investment returns.
Chart from www.moneysmart.gov.au
Most of your bills are going to be pretty predictable. These include your rent, electricity, phone plan Gym membership and Netflix subscription to just name a few.
What to do
Set up a bank account (yes another one!) just for bills. The reason everything is kept separate is so you have absolute clarity about your financial position. If it were in one bank account you wouldn’t know if a bill was coming out the next day, how much was for a holiday and what percentage you have saved for investing.
Again have an account with no fees and no penalties for withdrawing cash. Work out what your bills are to align with your pay cycle. If you get paid weekly and your electricity bill is $180 every 3 months then pay $15 (180/12) into this account. Again if you can arrange with your employer to have this portion of your pay to go directly to this account.
Now this only works well if you are a disciplined spender and won’t give in to temptation. If you are an impulsive buyer do NOT operate from a credit card!
A credit card can be great if used properly. See our post on ‘How the rich use credit cards’. It allows you to take advantage of any rewards programs on offer. Use the credit card for everyday expenses like your groceries and entertainment.
Ideally you would have the bills from above debited from your CC providing it doesn’t count as a cash advancement and trigger other fees. The aim here is to pay absolutely ZERO interest to the banks. Also avoid costly annual fees. These can negate any benefits that the card may provide.
FREE TRIP TO VEGAS?
*Note taxes for this flight would be approx. $400. However you can use points to cover these fees.
This account is the one you already have. You need this so you have easy access to cash if required as you don’t want to draw cash from your credit card. It’s also where your pay goes before transferring it to pay off your credit card. If your employer will only pay into one bank account you will need to set up automated debits from this account. It’s simple enough to do just arrange a nominated amount to be debited from this account and paid into your relevant account. Align it with your pay cycle.
The System at work
Exact steps to take
- Determine your income – Find out what your total income is. Look at your payslip and find the net amount for that pay period. The net is key because this will be after taxes and retirement savings have already been paid on your behalf.
- Workout a budget
- Start by finding how much you owe and who you owe it to
- Find your fixed costs like rent, gym memberships
- Find your variable costs like fuel and utility bills
- Seek money saving opportunities. Combining mobile and internet plans. Cancel unused memberships
- Set out savings and investing goals
Set up relevant accounts and direct debits as above
- Any left over money should be put towards debt
- Always pay credit card in full each pay cycle
- You may not get to this immediately. Work towards it by increasing income, decreasing debts.
- A general rule is to not pay any more than 30% of your income on housing. (Rent or mortgage) This is the level determined for mortgage stress