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Back to School with Your Finances

August 23, 2022

August is a bitter-sweet month. It marks the end of summer break, but it also represents the beginning of productive routines. The break in structure a summer vacation brings is a great reminder to add balance to our lives. There’s a place for rest in our lives, just as there’s a place for productivity. August reminds us to get back to earlier schedules and to be more responsible than we were in July. The first day of school marks a new year of maturity and growth. As our kids get back into the habit of waking up early for school, it might be a good time to get our financial planning back into “the school routine” as well.

A focus on the fundamentals is almost always the theme for the first few weeks of school. This is no different in your financial plan. Focusing on the fundamentals on your financial plan in these three ways to transition away from an indolent summer might help you gain more confidence in the coming years:

1. Estimate the amount of “lazy” money you need. In the current economic times, inflation is a true predator on cash and cash equivalents. Additionally, the topsy-turvy markets can invoke fear and confusion; however, given a long enough time horizon, volatile markets can be beneficial. The old adage that time in the market is more important than timing of the market plays a part here. Too little money on the proverbial sidelines can invite debt and worry, but too much money on the sidelines can lead to stagnation.

One of the easiest ways to calculate the amount of cash reserves you need to have on hand is to first calculate a basic month. A basic month is the amount of overhead it takes to live 30 days in a semi-emergency situation. This is a month with the bare minimum of expenditures: you don’t go out to eat much, you don’t go on vacation during a basic month, and you don’t buy unnecessary things. In a basic month, you pay your fixed expenses (mortgage, utilities, insurance, loan payments, etc.) and scarcely more. Remember, calculating a basic month is not an exact science; it’s an estimate. Every month will differ from the last but having a general idea of what it takes to live 30 days in your household is a helpful piece of information.

Once you have an estimate of a basic monthly expense, you can extrapolate how many months you may need to live in an emergency situation. If you need $10,000 to complete a basic month in your household, then you can easily calculate how much it would cost to last 3 months if there happened to be a family emergency. Once you know your basic month number, calculate how many months of storage you need to keep in the bank. How expensive is a really bad day? How long would it take to liquidate other funds? What amount of money feels right?

2. Establish a “medium-term” account. The short-term accounts are your bank accounts and cash equivalents. The long-term accounts are your retirement accounts that have early withdrawal penalties. The medium-term accounts are those with market participation (like the long-term accounts) that are accessible without penalty (like the short-term accounts).

These medium-term accounts can come in different forms. I like to see some of them in a taxable investment account. If you select your own investments, you need to have a grasp on what it is and isn’t taxable. Managing these accounts properly is important as to avoid additional taxes and take advantage of available tax breaks. Establishing an investment philosophy is critical here. If you rely on a professional, it’s important to understand the philosophy and what to expect from the account.

3. Put your savings on autopilot. Once you have the proper amount of money you should keep in your bank account, you can enjoy more productive money. I typically recommend automating a monthly contribution into the medium-term account. This way, even if you lose focus on your plan for a bit, something is still being saved.

To decide how much to save on an automatic basis, estimate your average income “overage.” If a normal month (not a basic month) costs $12,000 and your monthly take-home pay is $15,000, then your “overage” is $3,000. I’d recommend taking a portion of your overage – maybe one-half at most, one-quarter at least – and automate a monthly contribution. In the case where there’s a $3,000 overage, it might make sense to automatically save one-third, or $1,000 per month into the medium-term account. This allows your bank account to continue to grow at a pace of approximately $2,000 per month.

As you automate your savings habits and your short-term account continues to grow, you can make independent savings decisions based on your current needs and wants. You’ll watch your bank account grow higher than the amount you need to store, so you can then transfer the difference into the medium-term account on a consistent basis. I personally like to consider this on a quarterly basis. If I’m looking at my accounts in June, I can plan for increased spending for summer vacations and transfer less funds into the medium-term account. When I’m looking again in September, I can look at my accounts with a more serious tone, knowing that summer vacation is over, and I can transfer more.

It's easy to get overwhelmed with money and saving. Some of the concepts and rules can be complex, but applying a simple, automated system can help you get back to the fundamentals of your plan. Estimating what a month might look like if you needed to rely on savings for a stretch of time can certainly transform your understanding of the need for your bank accounts. As the seasons of the year change, whether it be summer vacations or harnessing the power of serious routines, your money and planning can equally reflect these changes. Establishing a future you can be proud of starts with a few fundamental steps, which can get your finances on track for success.