By Matthew G. Lipscomb, CLU®, ChFC®
It is very likely you haven't given much thought to how your checking and savings accounts are set up. But that could hinder your progress in achieving your overall financial goals.
Most people have a single checking account to which money flows in, and out regularly. That money normally pays for day-to-day expenses, such as a cup of coffee, as well as monthly bills. However, this setup is often the reason why only 4 percent of Americans reach financial independence in retirement.1
What are two of the biggest reasons that 96 percent of people are not achieving their retirement goals?1 The answer is the “human condition”, and our overall propensity to spend whatever we make.
Think of this: When you get a raise or when you finish paying off that new car, what happens to the “newfound” money? Most times, it just gets spent. Just like always: money comes in, money goes out.
But there is a better way to manage your cash flow and, thus, create a system where financial independence is much more likely.
The problem with the traditional family checking account is with the psychology that is involved, and how we tend to approach it. Subconsciously, there are subjective upper and lower limits in the account. If the value of the account drops below a certain level, stress ensues and spending freezes; if it goes above a certain level, spending increases. If there is still an excess of money, we may see fit to deposit some in a saving or money market account. It just so happens, although the levels are at different amounts than with the checking account, the subjective upper and lower limits still exist in the savings accounts as well. If this savings account now drops to a certain level, stress ensues and spending tightens. If it goes above a certain level, money is spent more freely. Only this time the purchases tend to be much larger and tend to have added, ongoing expenses (for example, a swimming pool, second home, etc).
There is little rhyme or reason to these spending moves. With this system, you're lucky to save much for retirement beyond the 401(k).
Using this form of personal cash flow management will rarely lead to financial independence: that point where your assets generate enough income to pay for the lifestyle you want.
That is where the Wealth Coordination Account comes in.
This type of account does a few things. It operates as a catch-all income account. More importantly, money coming in has a known and coordinated destination.
The monthly checking account receives the first cut of income. This is the required amount needed to live your lifestyle and paying your known bills—mortgage, auto, charity, insurance, gas, food, etc.
Once that is paid, the next chunk of money gets sent to the family “future spend” account. This account is a holding account for emergency needs or a family vacation. It can be spent with no worry or guilt.
That should leave you between 20 percent to 30 percent of your income for various wealth-building assets, which is the amount of your gross family income that must be set aside for the long-term. With a Wealth Coordination Account setup, money has a destination the minute it comes into the account. As a result, this last 20 to 30 percent goes out toward whatever wealth building assets you deem best and for opportunities that may come your way.
This strategy keeps you in full control of your finances, as you will know where your money is going. Plus, you'll have confidence knowing not a single penny is unaccounted for and that your financial goals are, in fact, on the path to reality.
1Source: Social Security Administration, Office of Research and Statistics, April 2000