Automatic transfers: The best non-budgeting budgetThis easy approach, recommended by Jane Bryant Quinn, is one of the best I’ve seen and is genius in its simplicity: Automatically transfer a portion of your paycheck into savings and retirement accounts, and spend the rest as you wish. The process requires some up-front time, but once you’re set up, you can set money management on autopilot. There are three steps to automatic transfers:
- Identify your saving goals and must-pay expenses
- Figure out how much you need to save
- Set up the transfers themselves
Step one: Identify your saving goals and must-pay expensesDepending on your age and stage in life, you’ll have different saving goals. You should always be saving for retirement; however, younger people might be paying off debt while older workers might prioritize a down payment on a home or contributing to their kids’ education. You may also save for short-term goals, like a vacation or big purchase. You’ll also want to account for anything you absolutely must pay for – rent, student loan payments, insurance, a minimum amount of grocery expenses, etc. The first step to non-budget money management is to figure out what expenses you can’t get out of, and what goals you want to work towards.
Step two: Figure out how much you need to save to reach your goalsYou can calculate your must-pay expenses based on previous spending, but deciding how much you need to save is a bit more nebulous. There are two ways to go about it: Goal-based saving, or percentage-based saving.
Goal-based savingIf you have specific goals like a vacation or a child’s college tuition, you can back into how much you need to set aside every pay period knowing only how much you want to save and how long you have to do it (CalcXML has a good tool for this). Retirement is a little trickier, since you have to make assumptions about your spending habits, how long your savings will last, and the tax climate. SmartAsset allows you play with different scenarios and come up with a monthly savings amount based on your standard of living and risk tolerance.
Percentage-based savingIf you don’t want to deal with the variables associated with goal-based retirement saving, you can follow rules of thumb. Most personal finance experts recommend putting at least 15-20% of your paycheck aside for retirement, on top of your other savings or debt payoff goals. Saving a percentage of your paycheck makes computation easier, and often, your employer-based 401(k) will allow you to automatically contribute a set percentage.
Putting it all togetherHere’s an example. Let’s say you want to save $2,000 for next year’s vacation, have $75,000 set aside for when your daughter goes to college in 15 years, and plan to spend $65,000 annually once you retire in 40 years. Assuming that short-term savings (like your vacation fund) are put into zero-interest accounts, and long-term savings (tuition and retirement) are invested with a 7% annual return, your monthly saving goals are:
- $167 for vacation
- $415 for college tuition
- $519 for retirement (with a few assumptions on benefits, inflation, etc.)
Step 3: Set up the transfers themselvesThe actual mechanics of automatic transfers are pretty easy. As we mentioned earlier, retirement plan providers like Human Interest allow automatic contributions to your employer-based 401(k), so all you need to do is enter what portion of your paycheck you want to set aside. Next, you’ll want to set up automatic transfers for all other tax-advantaged accounts, like an IRA for retirement funds on top of your 401(k) or a 529 account for educational expenses. Finally, you should create two checking accounts – one for your must-pay expenses, and one for discretionary expenses. You can have your paycheck direct-deposited into the discretionary account, and set up an automatic transfer to immediately move funds into the must-pay account. When you pay rent, insurance premiums, groceries or other inflexible costs, use the first account; everything else can come out of the second. From this point out, you won’t need to detail every single item you spend on – just make your purchases out of the discretionary account, and as long as you don’t overdraw, you’ll be able to meet your living costs and savings goals while still maintaining flexibility.
Is the no-budget approach too simplistic?Imagine that you’ve set up the no-budget saving approach, and then your car breaks down or your roof needs expensive repairs. How does this approach to spending and saving work? The above example left a few things out. First off, you’ll need an emergency fund to cover your expenses if you lose your job. As a rule of thumb, your emergency fund should be large enough to cover 3-6 months without an income. Past that, other goals may crop up, like owning a home or going to graduate school – or on the negative side, you might be faced with steep and unexpected expenses. For the automatic transfer system to work, you should make sure you have enough set by to survive financial curveballs. But if you’re not the kind of person who responds well to a super-detailed budget, a few hours of planning and a quick visit to human resources to complete the automatic fund transfer forms can let you live budget-free. In a more rudimentary fashion, that’s what my mom and dad did. There were no online calculators as they worked and saved. But they were disciplined savers. They made sure to set aside a portion of every dollar earned. They invested their money and spent sensibly. So although they lacked the fancy tools to automate their money transfers, they “paid themselves first” by manually moving their funds into savings and investment accounts. These days, you’re better off using the available planning tools and making your best estimates for your future expenses. That way, with a few hours of upfront planning, you can both live and save without a formal budget. Image Credit: Negative Space
Veteran portfolio manager, expert investor, and former university finance instructor. She has authored 3 money/investing books. Friedberg also owns the financial websites RoboAdvisorPros.com and BarbaraFriedbergPersonalFinance.com.