One of the most important keys that allowed my wife and me to retire when we did was financial automation. We took a lot of the discipline out of early retirement by simply setting it on autopilot.
It meant we didn’t need to think about saving money all the time.
Here’s the deal: It doesn’t matter where your money is going. Whether we’re talking your 401k, Roth IRA, a brokerage or a savings account, taking the time to setup automation once quickly turns your financial picture into a well-oiled machine, ripe for success over time.
Why is automation so important? It removes the element of discipline from the equation. We don’t have to remember to move our money to where it needs to be. We aren’t manually transferring our cash every single month.
We don’t need to lift a finger, ever, after we set up an automated process to save money. It’s all done for us, like clockwork.
Smart habits matter.
How to automate your finances
The meat of automation comes in the “how”. We understand that automation is essential. So, how do we set this whole thing up?
First, let’s talk about the easy one – a company-sponsored 401k plan at work.
If your company offers a 401k plan, enroll in it.
Money will be automatically taken out of your paycheck (before the government gets its hands on it!) and put in your 401k account.
This is pre-tax money that also reduces your taxable income. Participation in pre-tax retirement accounts is generally the easiest and most straight-forward way to automate saving.
Many companies will match a certain percentage of your contributions. A typical company match is around 4%, but it will differ from company to company. If your employer matches any percentage, contribute at least that much. Meaning, if your employer matches 4%, contribute at least 4%.
Be aware of the default savings rate that your company will set for you.
Typically, this percentage is less than 5%, which may not be enough for you. Save as much as you can. I like to encourage people to save at least 15% of their income – at a minimum.
But, don’t worry if you can’t save that much yet. It’s okay to begin saving just a few percent of your income and then gradually increase that percentage over time. You can’t forget to increase it, though!
Set a goal to max out your 401k in two years.
If your company doesn’t offer a 401k (or you want additional savings above and beyond your 401k), open up an IRA (Individual Retirement Account).
An IRA account lets you contribute money (up to $5,500 a year if you’re younger than 50, and $6,500 a year if you are 50 or older – as of the writing of this post) into an investment account. There are two different types of IRAs: A traditional IRA and a Roth IRA.
The biggest difference between a traditional and Roth IRA is when you pay taxes on the money that you contribute.
Traditional IRAs are taxable when you withdraw money later (it’s treated as regular income). However, your contributions are pre-tax.
A Roth IRA, however, front loads your tax burden (post-tax), but your money is not taxed when you take it out. There are some restrictions on who can invest in Roth IRAs based on your income.
The choice is entirely yours. Some believe that the pre-tax nature of traditional IRAs are the way to go, while others believe that paying taxes now, instead of several decades in the future (when income taxation may very well be higher) is the smarter move.
Whatever you choose, automatic monthly transfers make saving into these retirement accounts an easy and straightforward process. Just set it up once and forget it entirely.
After your retirement accounts are set up and automated, now it’s time to shift our attention to other accounts – like savings or money market accounts, that offer quick and easy saving options to nearly everyone.
If you don’t have a savings account, open one and use it to hold your emergency funds. Or, some people open accounts for individual purposes like gifts or college. Vacations. Really, anything.
To automate the process of funding your savings account(s), a popular method is monthly transfers from your checking account. Most banks offer an easy online tool to set up recurring transfers from one account to another – yes even at a different bank. This is generally the easiest method to establish customized savings schedules that work best for you beyond funding your long-term retirement accounts (401ks and IRAs).
Note: If you don’t have an emergency fund, start one now.
Open a savings account and create a recurring transfer from your checking account to that account. It doesn’t have to be much to start. But, even a little emergency money is far better than none.
How much is enough? I like to encourage at least three months of living expenses. If you lose your job today, are you able to fully fund your lifestyle for at least three months?
Savings accounts also provide you with good ol’ FU money.
Also, a quick note about automatic bill pay. I like the capability in general, but ensure that you pay close attention to these bills! It is far too easy for us to forget about those bills and not realize we are still paying them.
I have heard plenty of stories from those who cancel subscriptions, but somehow, their automatic payments didn’t stop. Oops!
Automation does not mean you should turn completely away from your monthly finances. After all, people DO get overbilled. People continue paying for services and subscriptions they no longer use. You’ll never know these things if you completely ignore your financial picture.
So, automate. But, don’t ignore.
Here is a challenge: Set up one automatic transfer
If you don’t yet have financial automation in your life, start today.
Make an appointment with your company’s HR department to find out about your 401k retirement options. Then, auto-deduct from your paycheck to start funding your retirement account.
Or, establish a savings account through a bank (we like Ally, but it could be with any bank) and create a recurring transfer from your checking account into that saving account.
Just start with one. Over time, consider other automation as well.
Check out the Automatic Millionaire, by David Bach, for an excellent in-depth look at how automation kicks our finances into high gear.