I was talking to a friend of mine about investing in cash flowing real estate a couple of weeks ago, and the conversation really made me think about things that I take for granted.
I want to be clear that she is an extremely intelligent person, is an MD, makes a great income, is married to another doctor, puts money away into her 401(k), and has a very nice house. She just isn’t into investing and doesn’t spend a lot of time thinking about finances.
When I asked her about how much she is looking to invest outside of her retirement accounts, she mentioned that they have about $200k put away – which is great.
But that is when the conversation got particularly interesting.
That $200k includes not only what they wanted to invest, but also money put aside for a large house renovation, their emergency fund, and their vacation fund. They didn’t have clear ideas of how much money was in each of those buckets.
Like many people, they were using a single bank account for all of their goals.
Since they didn’t have the allocations clearly defined, they weren’t sure how much they had to invest or how close they were to funding their renovation.
I have been using separate bank accounts for separate goals for so long, it was a good reminder that not everyone does that.
Many banks, including Capital One [1] (the one I happen to use), allow you to set up savings accounts with no maintenance fees and no minimum balances. When I have a new financial goal, I set up an account to track my progress (or repurpose an unused account).
I have accounts for vacations, taxes and insurance, home repairs, investments, and gifts.
Having goal specific accounts lets me easily see how much money I have saved.
It also lets me allocate money to each goal deliberately. I am not just saving $X, I am putting it towards a specific goal. So I can put $X towards my vacation every month, $Y into investments, and $Z for escrow. And if I get a bonus or otherwise generate some extra cash, I allocate it to my goals however I want to.
Of course, I didn’t come up with this method – it is closely related to “the envelope method” credited to Dave Ramsey [2] and used by many others. I just applied it to my savings goals, not my budget specific.
The benefit of this approach is that I know how much I can spend towards a specific goal at any given time without sacrificing other goals. If I want to take a vacation, I look at my trips account and can tell if I have enough to go to Europe or should consider a staycation instead.
It also makes it easier to invest in illiquid assets since the money coming out of my investment account is not something I expect to access for years. The other accounts have the money that I need in the near term.
After setting my budget and automatically allocating money towards each of my goals, I no longer question how much I have to spend towards each goal. I know where I am, can see the progress being made, and once there is enough money, I can spend it without any concern about whether or not the funds should be used elsewhere.
If you aren’t sure how much you have to spend on your goals, I highly recommend setting up a system like this to help gain clarity.
If you have any questions or comment about this post, please email them to me at blog@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.
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This article is my opinion only, it is not legal, tax, or financial advice. Always do your own research and due diligence. Always consult your lawyer for legal advice, CPA for tax advice, and financial advisor for financial advice.