Financial planning 101 - Step 3 - Automation
The continuing series around financial planning 101.
Step 1: Expense tracking
You have started tracking your expenses and have a view of your short term, medium term and long term expenses. This history is quite useful and continue to do this.
Step 2: Budgeting
You have opted to use any of the budgeting methods described in the blog post and you are sticking to those budgets every month.
Step 3: Automation - Pay your self first
As described in my previous post around emotions and market, the key factor that determines the success of your investment journey is to take the emotions out of the equation. You might consider yourself very rational and make financial decisions purely by analysis and research, but when the markets have corrected 25%, you will be tempted to second guess those decisions.
The easiest and most simple way to avoid the temptation is to not see this money credited into your account. How do you do it? I will explain, how I do it.
My firm allows me to designate multiple accounts for salary credit, bonus credit etc, which makes things easier. So I have setup my payroll accounts in the office HR system in such a way that I have my salary credited into 2 accounts, one account for all my expenses and the second account for investments. These bank accounts are in different banks and for the investment account, I do not even have an ATM card linked to it.
All my investments are routed automatically from that account via auto-debit / transfer instructions to my global, Asia and India investments without me actually having to do anything.
This not only helps me psychologically separate the expenses from the investments and see them distinctly in separate accounts. Also helps me stick with the budget on expenses which come from my main account.
I also do something else on day 1 of the new month, half of any remaining funds that I have in my main expense account, I have that out to my investment account. This helps me to save more if I didn’t spend the entire budgeted expense but also helps build up a cash buffer in my savings account which also acts as my local emergency fund.
Define your goals and the time horizons to fulfil them. Automatically route your investments towards these different goals according to different time horizons. I have the following goals in my India investments
Elder kid education
Elder kid wedding
Younger kid education
Younger kid wedding
India emergency fund
With regards to my global portfolio, I have separate goals again time bound
Again, these investments are automated and my account gets debited every month and the funds are allocated against these goals. My local emergency fund, I retain as cash in my savings account which returns 2% which is good for Singapore market where typical savings account only yields 0.1% return.
If your firm does not allow you salary credit into multiple accounts, you can still do this. Setup 2 accounts in different banks preferably. On the day of the salary credit, transfer whatever percentage that you want to invest into the second account, so that all you see in your primary account is what you can spend towards your expenses for the month.
The important thing is ensure that you are not tempted to stop your DCA / SIP based on market conditions and keep all of this running in the background like clock work without your need to intervene.
Given that you are already calculating expenses and budgeting, I am going to assume you are amortising large expenses as monthly expenses and are saving towards those as well. You can consider a third account for these if you want to segregate that, which is what I do for kids education expenses and other bigger expenses, but use whichever option that works for you.
Automation helps you decouple emotions out of the investing process and keep you on the path that you have setup. Review this configuration once a year which what I tend to do, but other than that stick to your guns and keep calm.
Happy Investing, up next
Step 4: Emergency Fund