Automating your finances means putting in place an effective system that manages your finances for you automatically everyday, without you having to stress about it.
By effective, I mean one that helps you save for a rainy day, be prepared for emergencies, and invest for the long term.
In this article, I’d like to share 3 tips (not trying to be clickbaity but 3 is the right balance between conciseness and coverage) that has helped me put aside a sum of money for investing and savings.
Autopilot is one of the greatest inventions in modern history – because it allows operators to focus on more important aspects of operations.
Number one: the psychology of automation
I would like to believe that deciding to automate your finances starts with a correct state of mind.
We are probably faced with hundreds of choices every day in life – at work, at home, at leisure or maybe just personal life decisions.
From easy ones like where to eat and what to wear in the morning to more complex financial issues like what kind of housing loan to apply for or whether this insurance policy is suitable or not; we will not have enough mental capacity to take full control of all the problems of our lives if we don’t build a system to help us.
As humans, we follow the path of least resistance – i.e. doing nothing – to help us make decisions. This psychology of passive decision making is important because it helps us understand that we need to structure a system that helps us do things without doing anything.
Let’s take an example of why investment plans from insurance companies are an attractive value proposition to so many individuals even though they suck from an overall return perspective net of costs. Imagine a $200 per month ILP from a leading insurer covering insurance, investments ands savings that automatically deducts from your savings account via GIRO every month.
To the most average and lazy human being, this automatic deduction removes any form of decision making for you. But, it promises so much opportunity – you can get savings, you can get insurance, you can get investment opportunities, and you can settle your financials automatically without any effort in a single plan.
This all sounds very attractive – that’s because it’s passive (no work) from your end – and that’s the power of a default option. Our CPF system in Singapore works the same way too – by automatically deducting a portion of your income before your salary gets credited into your bank account. When you don’t have to think about it, your salary gets drawn away by default.
Now, all we need to do is take this same system, apply the concept of default options, and create one for our own personal finances, without paying the middleman extravagant fees.
Number two: Default options for your personal finances
To create a bullet-proof personal finance system, you need to start automating by designing default options to influence the way you manage and grow your money.
Have a default option to automatically channel your money that comes into your bank account into separate accounts for savings, investment and spending right after your salary gets credited. Then, help yourself create simple mental rules to guide your automation, for example – you should only spend money and pay bills from your spending account.
Of course, you don’t have to create extremely strict rules like you can only spend $200 a month on food. Avoid these, as they create unnecessary overhead on the system.
Have your investment account ready to invest automatically as well. For example, a dollar cost averaging strategy with a regular savings plan or roboadvisor like StashAway can help automatically invest your money into a diversified portfolio of hundreds of dividend paying companies without you losing sleep should one go into bankruptcy.
Number three: automate and stay consistent
The last step would be to actually start automating your finances.
Here’s how I did it.
I start by creating a high-interest savings account such as DBS Multiplier or UOB One as my main account that acts as a funnel or checking account. I call it a funnel because when my employer credits my salary into this account, it funnels money out via Standing Instructions into various sub-accounts for a variety different uses automatically – one day after my salary gets credited.
I set up a standing instruction to channel a portion of my salary to a spending account (POSB Savings Account), a long-term savings account (StanChart JumpStart) and investment accounts (StashAway, Interactive Brokers).
Some portion of my funds remain untouched in this high interest account and it acts like a cash bank for me to draw money for emergency use, travel or investment opportunities. My emergency savings of 6 months’ monthly expenses are also stored in my long-term savings account and left untouched.
Why 6 months? That’s because if any emergency happens, you need about half year worth of expenses to buffer (e.g. it takes 3-6 months to find a new job after getting retrenched). This part is very important because emergency cash saves you from going into a wreck when sh*t hits the fan. The last thing you want is worry where to find money when the unexpected happens.
For automatic investment plans, there are a few good options from robo-advisors, regular savings plans, investments in mutual funds and many others. The important thing here is to choose one that you are comfortable with, ideally one with low fees and good reputation, and then stay the course through monthly contributions.
For bill payments and any outgoing funds such as contribution to parents, I like to have them set to automatically GIRO during the 1st day of the next month so that my monthly interest is accrued fully in the high savings account for the month. That means calling your credit card company and have all the billing cycles aligned. Having GIRO-ed bill payments ensures that you don’t forget to pay your credit card bills (and avoid crazy high interest charges for late payments!)
For my spending account, I used a budgeting app to track my past six months’ worth of expenses across various categories (food, travel, groceries, app stores, games, shopping) and used the monthly average as my fixed budget which I use to transfer every month. This comes up to about a third of my current salary, but since everyone has different spending habits and incomes, it’s best to find out what works for you.
Some people might find a stricter limit works for them, while others prefer to spend a little bit more. As long as you become aware of your spending habits, I think it’s a good habit.
Lastly, for dealing with incoming funds, I usually have any incoming funds that relate to spending go into my spending account (e.g. PayLah transfers from friends, cashback from ShopBack). All other funds, especially those relating to portfolios (e.g. dividend income, interest income) go into my main account (the funnel), or get automatically reinvested.
That’s it! I hope this post was useful for those clueless about automating your finances. It’s simple, easy to follow and it’s actually just all about standing instructions on fixed schedules.