What cannot be measured cannot be managed. If you want to become financially independent, you will learn to love this quote. In order to have control over your money, you must first understand the ins and outs of your financial system, your financial ENGINE. A sound engine runs cleanly and with minimal waste. It also requires minimal maintenance. If you want the most happiness per dollar out of your engine, you will build it to run as efficiently as possible.
How does your financial engine run now? Does your money flow from place to place seamlessly? Is there leakage? Do you have idle cash sitting around, being depleted by inflation? If you answered yes to any of these, it may be time for a tune-up.
Many Middle class Americans have engines that are simply idling. Many have even set their engines to run against them in reverse. To get into drive, you have to turn your dollars into employees. You have to organize your bills so that they work hard for you and manage themselves. This is done by keeping them where they can reliably earn interest, such as index funds (earning 7% in the long haul), paying down debt (saving you from paying interest) and finally, high interest bank accounts. There are a handful of other investment platforms, such as dividend investing or peer-to-peer lending, and of course lets not forget tax advantaged retirement accounts. For now we’ll stick to the basics.
For a typical person, each time the paycheck rolls in a small chunk goes to the 401k or whatever retirement options your employer has for you. The rest goes into a brick and mortar bank account to earn a pathetic 0.10% rate of interest. It does not stay here too long however, life’s little expenses chew it up rather quickly. People are often surprised month after month how quickly their accounts are depleted.
You, on the other hand, are different. You understand the magic of compound interest. You know that you can make it work for you or against you. You know the future value of your money if treated correctly, and your fresh perspective allows you to spend only on the things that are important to you, while cutting out spending on all the rest. With this you experience a surplus of cash. What do you do with it?
You throw it into killing your debt, into maxing out your 401k, and in taxable index funds. And that little bit you need for your expenses? Into a high interest online savings account. Online savings allow you to earn up to 1% on you money, all while keeping it 100% liquid for when you need it. Sure, inflation is 2-3%, so this money is still slowly being depleted, but you are only keeping money in there that you will need in the short run, say, three months worth of living expenses. The rest of your money is tucked away where it will be easily beating the rate of inflation, growing your wealth while you eat and sleep. Every morning you will wake up a little wealthier.
Online savings accounts have incredibly low upkeep due to not having physical branches. Without having to cover the costs of bank tellers and managers, they have plenty of savings to talk about. They pass these saving on to YOU, via high interest accounts. If you love the idea of being able to walk into a physical bank, then by all means, keep an account open in a brick and mortar. You can still keep your money in an online savings. When you need money, simply make a transfer online to your physical bank, then you can walk in and make a withdrawal. You can even set up automatic transfers to minimize work on your part.
Online banks are just as safe as brick and mortar ones. You can find plenty that are member FDIC. I personally use Ally. They offer 1% on their savings and account setup was very simple. They also have excellent customer service. Do not just follow my word though, do some research. There are plenty of options out there. I know some online banks like Capital One 360 will even give cash bonuses just for opening an account.
As for you 401K, this will have to be discussed with your employer. Most of the time there is matching of about 5%, along with nice tax benefits for the rest.
And as for earning 7% on the rest of your savings? Index funds. I highly recommend Vanguard. They have the lowest fees out there and excellent customer service. More details on index investing here.
Between your retirement accounts, index funds, and online savings, you now have your money working hard for you day and night. You are minimizing the effects of inflation on the money you need to keep liquid and you can lower your work through automatic transfers. The money that goes into your investments should come straight from your paycheck. This decreases your workload and gets your money working for you faster.
Remember there will always be room for improvement in your financial engine. Check back on it from time to time to make sure it is running smoothly.
You engine seems to be running a little more efficiently now. You can kick back and enjoy a drink with the time you won’t be spending managing transfers or worrying about stock picks.