Stash Your Cash and Manage Your Savings

Managing your savings is equally as important as accumulating them in the first place. If a deliberate savings structure is not in place, excess cash and saved funds can be easily mishandled, converted into unnecessary expenditures or handed over to financial institutions in the form of obscure fees (e.g., one of the worst offenders, Bank of America earns $1MM in fee revenue per branch annually). These savings drains are undesirable, but can be avoided and minimized by directing funds flow in an organized approach. This post will be different from the previous ones – instead of discussing a tactic to obtain new savings (e.g. by lowering food expenses), it will focus on a strategy to funnel and keep savings intact.

Begin with a Centralized Savings Account

The focal point of your savings plan should revolve around a centralized savings account (or CSA), preferably an online one. The key benefits to online savings banks are lower overhead which allows them to offer a higher savings yield, free transfers between financial institutions, advanced features like mobile check deposit, and better security (funds cannot be transferred to a newly linked account or readily withdrawn if set-up properly).

BankRate.Com provides an up to date list of savings accounts based on yield. A present-day competitive bank will likely offer comparable rates over the long-term, since the yield is typically offset from the federal funds rate. Select a reputable online bank that offers a high rate (but do not focus on chasing the absolute highest return – no more than $10-15k should be in this liquid account at any given time and a 0.25% rate difference results in a mere additional $20-30 annual after tax gain). Instead, choose a bank that offers additional services such as a free online checking account with bill pay, ATM access, mobile check deposit, etc. The Finance Doc has happily used Capital One for a long time, but has received strong recommendations for Ally Bank as well.

The Finance Doc’s Funds Flow

Fund Flow Around a Centralized Savings Account

Once established, the CSA should be set-up to receive direct deposits from employment and all check deposits to earn the highest short-term yield. After a sufficient balance has been reached ($10-15k), any excess funds should be transferred into an investment account, such as a taxable brokerage account or a tax-efficient Roth IRA account, with a reputable low-cost brokerage such as Fidelity, Vanguard or Charles Schwab, etc. One does not want to accumulate a large balance in a CSA account, since the yield on the balance is usually below the inflation rate, resulting in a negative real rate of return. The true savings vehicle in the diagram above is the taxable brokerage. Funds there can be accumulated to make future down payments, car purchases, education expenses, etc., while growing wealth at positive real rates of return.

In the above diagram, one should direct funds toward one of the blue accounts on the right, primarily through the structures and transactions in green. Immediate cash liquidity or small personal income (e.g. from Craigslist or eBay sales) should be accessed through financial intermediaries in yellow and all major or recurring payments should be funneled through the accounts in red (with payments reduced over time).

Linking Checking Accounts to a Centralized Savings Account

The CSA should be linked to two separate checking accounts – a (preferably) online one for making all payments and another account that can be used to access cash and make small transactions with other institutions. By making all payments through a single account, it becomes exponentially easier to track and stay on top of one’s spending. An online bill pay option saves time and automates payments for mortgages, loans, and credit credits (one can also make all check payments to individuals). A minimal balance should be maintained in this account since the yield on the balance is insignificant.

The yield on the latter physical bank checking account is also not important, as one should expect to keep the minimum amount in the account to avoid monthly maintenance fees (I prefer to keep a spare $100 buffer to avoid getting hit with charges*). Instead, make sure the checking account is free to use and look for features such as branch banking and a broad network zero-fee ATM access, while avoiding some of the worst offenders above. You should connect PayPal, Venmo and other services to this account to keep the majority of your liquid savings secure.

Savings Overview

Summary: Set-up a savings structure similar to the diagram above that isolates immediate liquid savings (centralized savings account in green) from long-term savings (blue boxes), short-term cash access (yellow boxes), and payments (red boxes). Optimize yield in the CSA, while looking for features and minimizing fees and account balances in red and yellow boxes. Ruthlessly move savings towards the blue accounts to grow wealth.

Amount of time to implement: Depending on existing accounts open, upwards of a week to sign-up and link properly. Learning new account features and setting up online bill payment will take further time to learn. No additional time to maintain, as funds are expected to be automatically shuffled between various structures.

Savings: Potential to decrease spending in general by monitoring all outflows via a single account. Additional savings by limiting financial institution fee charges and a higher return on liquid savings through an organized approach to managing finances. Positive real rate of return on the majority of savings with taxable and tax-efficient brokerage accounts.

 

* – If you ever get hit with a monthly maintenance fee, call up customer service and they can usually refund your fees from the last 30 days.

 

Update: Some alternative savings management outlines have recently been shared by BudgetOnAStick and TheLuxeStrategist.