The best way to ensure that you save and invest is to automate the process. For our clients, you’ve already got the investing automated by working with Marotta Wealth Management. Now, you just have to automate the savings.
One of the easiest savings plans and the one I recommend is called “The Automatic Millionaire.”
The strategy is implemented by setting up your income, be it Social Security checks or wages, to directly deposit into a brokerage account and then, through automatic money movements, dispatch funds to the appropriate locations, leaving any remainder behind as invested savings.
The dispatches would likely be a portion to your checking account for daily expenses and a portion to fund each of your Roth IRAs if you qualify for contributions. Any remainder would be your brokerage account’s invested savings or emergency fund.
Here is the strategy described in more detail:
The first step is to automatically deposit all of your sources of income into your brokerage account. Include all of your income sources like your wages, paychecks, Social Security, pensions, or immediate annuities.
Direct deposit can be established for most income streams be they a paycheck from your employer, your Social Security check, or even your pension deposit. Most of these just require acquiring a form and filling it out with the same basic information:
- Name of Institution
- Account Number (this is normally your 8-digit number plus additional institution-specific numbers on the front)
- Routing Number
- Account Type
As a Schwab client, you can get your direct deposit information by logging in to Schwab Alliance at https://www.schwab.com, and then, under the Accounts tab, click on “Transfers & Payments.” On the page that loads, scroll to the bottom and click on the “Direct Deposit” link. Then on that new page, select the appropriate account in the blue drop down menu. Then, the information you are looking for is under the heading “Direct Deposit and sending money to a Schwab account.” At the bottom of that section is a link to create “Printable information to give to your employer.” This generates a PDF with direct deposit information for the account selected.
Give that PDF to your employer, pension, or other institution to request that they directly deposit your future payments into that account.
You can read more about this in our guide “How to Set Up Direct Deposit.”
Set Up a Money Link
The next step is to link the account receiving the direct deposits to the account out of which you pay your bills. If you use a Schwab Bank checking account linked to your Schwab brokerage account, this step is already done.
Otherwise, you will want to set-up a MoneyLink between your direct-deposit account and your bill-pay account. To set-up a MoneyLink, follow the steps in our guide “Move Funds Between Your Bank Account and Your Schwab Account” or work with your financial advisor to prepare the paperwork.
Plan the Distribution
If you know what your monthly standard of living is, then determining the size of your distribution is simple. We recommend distributing that monthly amount from your Schwab brokerage account to your bill-pay checking account.
If you aren’t sure how much you spend, there are a few strategies. You could distribute to your bill-pay account the amount you hope your standard of living is and then find out if you can live on that. For example, you could distribute 75% to leave 15% for retirement and 10% for unknown expenses.
Alternatively, you could withdraw all but a small amount. For example, even leaving behind $300 per month ($10 per day) would be worth $1 million dollars over a 45-year career earning 7%.
Once you have decided on an amount which is less than the amount being deposited, you can use the variety of options Schwab has available for scheduling recurring MoneyLink distributions ranging from Weekly to Annually. Then, see if you can live on what you’ve allotted yourself.
As you adjust to the new system, it will be important to keep an eye on your checking account. If your checking account is building up money, you are likely transferring too much. Alternatively, if your checking account is dwindling, you may not be transferring enough. Having a checking account that becomes flush with money defeats some of the purpose of automating your savings.
If cash builds up in your checking account at the end of the year, simply lower your distribution and transfer the remainder back to your brokerage account for investing.
If you find you need more to spend, simply ask us to generate more cash and increase the future distribution.
This extra hassle can be seen as an advantage because spending more than you have intended will require additional conscious effort. The goal is to design it in such a way that, without effort, the default will be saving and investing.
Create a Small Cushion
To get started, we recommend that you make sure your bill-pay account has two or three months worth of your spending.
This can be accomplished before even the first direct deposit and automatic distribution by either distributing cash down or up to bring the bill-pay account to the right target.
Having an extra month or two worth of spending would mean that shortly after your automatic distribution the account will be flush with cash. Then, as the month goes on, you’ll spend down your account.
This extra cushion helps when you have a month where you typically have more expenses, such as the December holidays or summer vacations.
Fund Your Retirement Accounts
Saving in a taxable account costs more than saving in a retirement account. As much as possible, we recommend you prioritize funding the retirement accounts available to you.
As a result, we recommend you either automate retirement account savings using a recurring journal or make sure to leave behind enough in the account to support your annual account funding.
Your 401(k) or other retirement accounts at work are deferred before the direct deposit. However, you need to intentionally contribute money to your Roth IRA and your health savings account (HSA), for example. For a more complete list of account types to consider funding, you may benefit from reading our Account Funding series.
Review the Plan
Knowing how much you spend can be difficult, and most of our clients don’t know the answer before working with us. This is especially difficult as savings, taxes, and other large cash flows mask lifestyle expenses. Often people suggest a lower number than their actual needs. This is probably either because they are discounting the infrequent but significant number of large purchases that everyone makes on a sporadic basis or because they are not counting a category like big expenditures because each individual expense feels like it is a one-time exception.
Don’t worry if you experience a learning curve as you find the right size regular distribution to meet your spending needs. The effort spent is amazingly valuable. In retirement planning, knowing your specific standard of living is one of the most important factors. Meeting retirement goals requires knowing your specific standard of living.
At year-end or after a large project at work, you may receive variable and unexpected bonus money or a promotion which increases your regular pay. The beauty of the automatic millionaire is that by default these funds will be saved and invested. As a result, if you do make more than you thought you would, don’t change your recurring distribution. Instead, leave it right where it is and let the new money be saved.
If some of your income sources are from a fixed pension or an immediate annuity, we recommend taking care not to count on all of those funds and asking our team to analyze how much you can safely spend. Fixed pensions and immediate annuities will not go up by inflation and spending all of it is not advisable.
By decoupling your standard of living from the size of your income, you have taken the first step toward financial freedom.
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