Two of the big rules of personal finance are to automate your finances and pay yourself first. They go hand in hand to a large extent, you figure out a budget and what your regular bills are and get direct debits setup, then you decide what you want to save and have that money go directly into a savings account for share purchases or a regular investment plan with a managed fund. If you don’t see the money that you’ve saved then you won’t be tempted to spend it is the thinking and for the most part it works pretty well.
So why don’t I do it?
With this blog I try to talk about how things actually are rather than how we think they are or want them to be.
I’ve talked pretty extensively about how things actually work in these posts on sequencing risk, the 4% rule, why we’ll most likely hit it during a bull market, how long it will take to hit FIRE, if we can control when we hit it, or build a bigger safety net.
Plus these posts on what could go wrong and how I protect myself and my family. Then this post on your budget vs your actual spending. And this one on why there is only so much you can tighten your belt.
The reality is that life isn’t smooth. We don’t start work at whatever age and get a steady 3% pay rise every year for the rest of our working lives, we don’t get a smooth 7% real rate of return, we don’t have steady expenses the whole way through. Life is irregular. We get pay rises in big dollops as we get promoted and moved into different roles. Sometimes we get made redundant and don’t have any income for a while, I talked about being out of work for over a year during the GFC . The returns on our investments are mostly positive but sometimes negative. Our expenses fluctuate depending on a bunch of different factors. We have big lump sum purchases like a new car or a house or even just a big holiday.
At this point you may be thinking well that’s all true AHF, but what’s that got to do with automating your finances and not paying yourself first? First things first, it’s not as though I don’t do it at all. All my regular bills that can be setup on direct debit like internet, phone, health insurance, utilities etc are paid that way.
But a lot of the bigger bills aren’t setup on direct debit, and my transfer to my savings account isn’t. Why is this you ask? Well in the case of the bigger bills like personal insurance, car insurance, house and contents insurance etc you often get a pretty big discount for paying a lump sum instead of on a monthly or fortnightly basis. In a lot of cases it’s a month less that you have to pay, or up to 10% in others. That’s a pretty substantial guaranteed return, and I am a big fan of substantial guaranteed returns.
The issue that creates though is that at certain times of the year, I’m going to have big irregular expenses. My rates are due in February, that’s a couple grand. My house insurance is in April, that’s another grand. My personal insurance is in August, that’s about 4 grand. Car insurance and registration are in November, that’s a bit over a grand.
Then there are things like medical expenses which come up from time to time and can be large as well, although so far I’ve been pretty lucky. Buy some furniture or a new phone or computer (all of which we’ve had to do this year) and all of sudden you can have some big lumps of expenses.
And then on the flipside I get dividends from investments at various times of the year as well, mostly around January and July but also in April and October as well as a couple of random ones throughout the year. And yes I could have at least some of these setup on dividend reinvestment plans but I don’t for a number of reasons. These can be a couple thousand dollars or more and change how much I can put aside each month as well.
Like most people I have a target amount to save over the course of the year. If I wanted to automate things it would mean dividing that target amount by 12 and having it automatically transferred to a savings account each month. But the problem with doing it that way for me is that some months too much would be taken out and I’d be short on cash and other months not enough and I’d have an excess sitting in my bank account.
There are a bunch of ways to get around this of course. I could just transfer a regular amount to my emergency fund and draw down from there for any big stuff but then I’m getting myself accustomed to drawing down from my emergency fund for non emergencies and also run the risk of not having enough in there when it’s an actual emergency.
I could set up a separate fund to help me smooth out the cashflow better and just draw down from that but that means yet another bank account and I have far too many already, plus it’s money which isn’t working hard for me.
I could use my credit card to pay those big bills (and I do unless there is a surcharge for using the card) but then it just delays the problem with my lumpy cashflow rather than fixing it.
What I actually do is manually transfer the excess cashflow each month into investments (well cash at the moment as I wait to see what happens with the election and subsequent legislation as described here). The obvious potential problem with this is that I might instead succumb to lifestyle creep and spend the money but so far that hasn’t been an issue.
This definitely isn’t the right approach for everyone. To the extent that you can easily do it I highly recommend automating as much of your finances as possible which is what I do myself. And if you’re young then you may not have a lot of the bigger bills I have like rates and house insurance (although you should have contents insurance) so you can just have everything paid each month automatically, and do the same with paying yourself.
But as you get older and you most likely buy a house, take out personal insurance and life becomes more complex in general you’ll find that your cashflow becomes a lot less smooth. And at that point you may have to choose between whether you want to spend less on those expenses by paying them on an annual basis but complicating your cashflow, or keeping things nice and smooth and paying more?
How do you deal with irregular cashflow? If you enjoyed this post and would like to read more like it then please subscribe!
Good post AHF
The dilemma on lumpy big expenses and managing cashflow is ever-present for us too
Current strategy is zero sum budget with allocations to big expenses spread equally over fortnightly pays and kept in our daily expenses transaction account as well as a set amount automatically transferred to a pending FIRE investment account each pay
It works most of the time, but also requires watching spending across categories to ensure lifestyle creep is kept at bay and we actually stick to allocated budget more or less – we use money brilliant for this
We pay almost everything through credit cards for reward points, and on occasion may find the funds in the daily expenses account may dip a bit low, requiring a temporary top up from somewhere else. Generally I would use funds from pending FIRE for this (we wait for 10K to build up before investing, so there are usually spare funds), but are trying hard not to do this and manage not to most of the time
We too ignore our emergency fund for cashflow management, which is about 12 months of essential expenses and with another bank, and don’t touch it either, so it doesn’t help with cashflow management
A bit of a work in progress for us, but with a fixed allocation to investments we stick to based on what we can contribute from the zero sum budget, and we are on track with that amount so far this year
Hey Craig, glad you enjoyed the post!
Like you I try to use credit cards in all circumstances except when there is a surcharge (like at Aldi) which means that it costs me extra to do it that way, in those instances I just use a debit card.
Thanks for sharing your streategy, it sounds a bit more complex than mine! Whatever works for people is the main thing and if you’re on track then that’s great!
I had that same question just a few weeks ago. To lump sum my life insurance or to do monthly payments? One would hit my cashflow in the gut, but presumably if I factor it in properly, I could definitely do it in a few months time. In the end, the question was asked to me by a 3rd party: is the difference going to earn you enough interest in that 12 months to justify the cashflow choke, especially if we did it right there and then without having budgetted it in for the year?
In my case, my difference was $300. And I ended up sticking with the monthly payments.
I do automate my savings, but I don’t do a zero sum budget. I will always have leftovers, and any excess money is dealt with at the end of the month into various savings or investment accounts. This allows me to feel secure that if nothing else, I did have a baseline amount making their way into savings every fortnight.
Hi Pia, thanks for stopping by!
There’s definitely no right or wrong way of doing it, just whatever works for you. The difference for me in the premium was about the same as with yours and I went with the lump sum, for me it worked fine to lump sum it but for others having a regular predictable payment makes more sense. Horses for courses as they say.
Once you get past the fairly basic maths of finance so much of it is behavioural. I don’t mind having some months where I don’t make any additions to savings, you obviously prefer it. It’s about figuring out what works for you.
Oh and congratulations on getting your blog back up and running again!
I run my finances pretty much the same way you do.
I just have a spreadsheet with all of my categories set out, with due dates for things like rates and insurances, and shovel money into a high-interest savings account. I live off my credit card, which is always in surplus, and it all seems to tick over very nicely.
Great minds think alike Frogdancer!
BTW even though I keep subscribing to your blog it never seems to send me notifications of new posts? I’ve tried doing it again today, hopefully it works this time!
I’m probably in a different position to many being a bit older before discovering fire. With PPOR already paid off all my borrowing is investment based for additional properties.
By using a multi offset account (1 loan and multiple offset accounts against this loan) you can siphon off money into an account that can be both used for a specific purpose – expenses, car replacment, holiday etc and, until used, reduce the amount of interest you pay.
The other unintended, but welcome, consequence is that if I need to use the offset money for a car etc it is effectively now tax deductible borrowing.
Hey notmissing work!
I must admit I wasn’t aware that you could have a multi offset account, is that something which most banks offer?
Those that offer it generally allow up to 10 accounts to be offset against your loan.
BankWest and most of the smaller banks and credit unions do it. Westpac doesn’t. I don’t think NAB allow it.
Just a matter of checking and make sure that they are 100% offset against the loan.
Hi, I love reading your blog, and I like this topic, it’s great to know how others do this, I found that friends don’t always like to talk about this.
I think every case and strategy is obviously different based on personal circumstances. In my case: employed, no mortgage, no car, pay rent, single, no debt, no pets and no kids.
I have studied a bit of wealth building and personal finances and tested to see what works for me. I plan my whole year ahead and know when I need to pay for insurance, dentist, electricity and bills. Depending on how large the bill I save for a few months in advance for a big expense. Otherwise I know in advance that my surplus for that month will have to pay for it.
I have an emergency fund which I have used for emergencies with family overseas.
I also learned a rule from a mentor which he calls Forced Accelerated Saving, the idea is to start with saving 10% of your income (or the amount you can) and increase this amount 10% every 3 months. This is to accelerate the effect of the compound effect. For some people in this community may not be suitable because most of us already save much more than 10% but I would still challenge those who believe they can’t save more money than they currently do, we can become creative in finding ways of finding extra money.
One way of doing this, as an example: if you’re going to meet somebody for lunch and they pay, take the money that you were going to spend in that lunch and put it to savings.
The point I’m trying to make and that I learned from this guy is that organised ever growing finances create somehow more money and minimise volatilities and I have experience that myself. I have fund higher paying jobs, coincidence? who knows? This process includes even with how organised we carry cash in our wallet, tracking finances diligently, etc.
I also have on my fridge my vision of why investing money and what I’m trying to achieve so that I remind myself every single day that I’m not just “saving”, “buying shares”, I am instead creating a solid foundation for me that will grow and will last beyond my life time etc etc etc , something like that. This helps me also to stay on track and avoid the temptation to overspend in depreciables.
Hi Plutarch, great to hear you’re enjoying the blog!
As you say so much of it depends on your personal situation and you have to find a system that works for you.
Forced Accelerated Savings sounds a bit like the Save More Tomorrow program which Richard Thaler and others came up with. I think it probably works a lot better if you aren’t already a large percentage of your income but for newcomers it may be a more sustainable way of getting into FIRE.
Having your end goal in mind and something to keep you on track and focussed is huge. For me I find that this blog and following others really helps me with not being tempted to make bad decisions with my finances. For others it’s presumably different things, but without a goal in mind and cosntant reminders it’s a lot harder to stay on track!
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We don’t automate our finances for similar reasons. The only thing we automate are our regular deposits into our investment bonds.
I personally am not too concerned about smoothing out our income and expenses. I run a zero sum budget so I know exactly how much is allocated towards expenses vs investments. Once the investment bucket reaches a minimum of $5k that’s when it gets invested into the market.
There is a lot of benefit in automating finances but like you said, it doesn’t work for everyone, and we all need a system that works for us.
Good to hear I’m not the only one not automating things Ms Firemum!
And congratulations on your feature in Harpers Bazaar!
There are a few measures i have found to smooth out the “lumpy Bills” . I have multiple offset accounts under the same loan (Macquarie). I have a transactions account, Expenses account, savings account & a tax account all offsetting my loan. I live off credit cards that are paid back monthly.
Best measure i find is to divide up ALL the big lumpy expenses you know are coming over the year by week or fortnight (depending on your pay cycle) then once you have this number figure out how much needs to be put aside weekly or fortnightly to cover, then setup an internal funds transfer for this amount, plus extra for “unknown expenses” mine is $1500 a fortnight (health insurance, rates, home & contents, car maintenance, regos, license renewals, electricity, water, mobile, loan payment, property maintenance and more) setup all your expenses as direct debit from this account. Then you only need to review once every 6 months or so. This is a bit of work to setup initially, but this has worked perfectly well for me for a long time, i dont even think about it any more.
When i review every 6 months its more me shopping around for better deals, adding or removing payments.
Hope you dont mind me sharing, i just came across your Blog 🙂
A far better explanation of what I do!
If you can have multiple offset accounts that definitely makes sense to use for any big expenses.
I can see how having a separate account for all the lumpy expenses would make sense but for me at least none of them are so large that I can’t pay for them out of ordinary cashflow easily enough so I just do it that way instead.
And no problems at all on sharing!
Really enjoyed this post! I cracked up at the ‘I am a big fan of substantial guaranteed returns’ line…
The trade-off between more convenient monthly payments and lump sum discounts is something I often have difficulty deciding on. What is the percentage difference that makes the upfront lump sum worth it for you?
Haha glad someone else gets my sense of humour Kurt!
As a generalisation anything over 5% makes it worth it for me to go the lump sum route, but then I want to look at the actual dollar amount of both the discount and the remaining bill. I don’t have any bills which are over a couple thousand dollars where I get a discount and I can fund anything below that amount out of cashflow so long as I don’t have two of those coming at once, which fortunately isn’t the case. So pretty much anywhere I can get a discount for an annual payment I take it. That might change over time depending on what happens with my insurance premiums, in particular the personal insurance stuff where it might creep up to being more than is easily payable from one month of cashflow, but at the moment it’s manageable.
This isn’t an approach that will work for everyone though, thankfully I’m disciplined enough to make the savings in the months when I don’t have big bills coming but a lot of people will be better off just automating everything and miss out on a bit of discounting but end up investing a lot more because they don’t have to make a conscious decision to do so.
Hope that helps?
Hi AHF, sorry mate, I wasn’t notified about your reply – must have forgot to check the box…
5% at a tax rate of 32.5% is about 7.4% after tax – that’s definitely a substantial guaranteed return! Thanks for sharing, I really like having rules of thumb I can make quick decisions on the fly with!
Thinking about it, you must have your cash flow calculations dialed in to deal with lumpy obligations the way you do – it’s impressive! I tend to dip into the Emergency Fund when they come up. Not ideal, I know, but I’m pretty young and automation has worked well enough for me so far.
Thanks again!
I think there is a certain element of luck in that my system actually works, but thanks for the compliment! When we moved back to Oz a few years ago pretty much all our big expenses like car insurance, rego, contents insurance came due at the same time a year on because everything was set up simultaneously. Thankfully when we moved house a year or so ago it spread out our expenses over the year a bit better otherwise it’d be unworkable.
As far as having to dip into the mergency fund from time to time, that’s probably ok as well depending on just how much you have in the fund.
At the end of the day you’ve got to find a system that works for you. If you’re young automation is probably easier because there are less lumpy expenses and it means you don’t have to use any willpower to make it happen!
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I also don’t automate. For one thing, my cash stores are kept in my offset account where they are giving me guaranteed returns against interest. Like you, I optimise my big bills to be lump sums when discounts are available e.g. with car insurance. Additionally, my *income* is variable from fortnight to fortnight, and my cash flow is pre-tax income — tax is payable quarterly, so that’s another lump sum!
If you have an offset account then that definitely makes sense!
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