For being a finance nerd, I’m a bit embarrassed to admit that savings has always been a confusing subject for me. In my mind, there are three financial buckets that I can understand putting my money into: spending account, long-term investing account, and backup emergency fund. Once I’ve built up a cushion that could allow me to survive a few months with no income without having to liquidate assets, that’s all good, but should I do anything beyond that?
For years, this ambiguous purpose of a savings account meant that it just ended up being my way to make bigger purchases that I didn’t budget for. I would always have at least $1,000 in a bank account sitting idle, but if it grew to $4,000 I would just take $300 of it and buy tickets to a Seahawks game, or buy a new iPhone. While this was still being effective in it allowed me to enjoy these more expensive purchases without having to put it on a credit card that accumulated interest, this lacked the intentionality I operate with for the rest of my finances.
A More Purposeful Way to Save
This frustration led me to experiment with an idea: what if I just designed an account that I contribute funds into over time, and then in a couple of years, I just cash out the balance and that becomes a large lump sum that I get to use that year for whatever I choose?
My actions indicate that I value having cash available to spend on large purchases, so instead of fighting that, why not create a system that provides that in a more intentional way? We like having large tax returns because they provide a large sum of money all at once so we can go on family vacations, or to buy a new car, but that is an inefficient system that doesn’t leverage compound growth since it’s just overpaying your tax bill over the year.
In 2014, I took this idea and put into practice: I would take a portion of my budget that was allocated towards savings and would start investing it over 3 years. I would just invest in simple ETFs that were relatively stable, and while it probably wasn’t the safest option since 3 years isn’t long enough to withstand market corrections, I was willing to still just play around with the idea.
But anyways, so the idea was I would invest roughly $20/week into a fund from 2014 to 2017. Once 2017 came around, I’ll be free to cash out the account and spend it on whatever I would like. When 2017 did come around, I had accumulated a balance of over $4,500 that was now free for me to use! Since 2017 was when I graduated from SPU, I decided that I would use the $4,500 as a 1 year buffer on student loans. So now it’s 2018, and I’ve been paying extra on my student loans at $350 per month, but I haven’t had to even think about it since it’s coming from my $4,500 balance.
That is the power of small contributions being compiled together. Long-term investing takes this concept and grows it exponentially, but we also don’t need to wait 20+ years to enjoy the benefits of saving; just a couple of years can add up to something meaningful.
That $4,500 was great, but I want to have another $4,500 this year as well. I didn’t exactly plan for this initially, since I just wanted to see if this would even work, and I figured that I could just benefit from getting a nice boost every 3 years. Eventually I actually did try to leveraging this concept to grow exponentially, and shortly after I started the 2017 fund, I opened a 2020 fund and started putting just tiny bits into the fund at the same time as I was investing in the 2017 account. I would put $20 into the 2017 account, and then would add another $3-5 into this new 2020 account. The idea was that I could get a head start on this next 3 years by just putting smaller portions into it, and then when I cash out the 2017 account, I would already have money in the 2020 account before I start taking that same $20 weekly deposit into that account that I was putting into that previous 2017 account. This would make 2020 theoretically even bigger even though it’s still only 3 years after the first one.
Reinventing the system
My initial experiment was a success: I was able to take some of the funds that were just a catch-all budget buffer and transformed it into a lump-sum payment method that became something meaningful to me. But now I wanted to reevaluate the concept and see if I can restructure it in a way that allows for a cash out every year to occur with similar impact.
What I came up with is a revolving 5-year program, where I set up 5 different accounts with one expiring for each of those 5 years. At the beginning of the year, I would cash out one account, and then simultaneously open another one for 5 years out, thus always keeping 5 years of investing in place even though one expires each year. Another concept that I changed was instead of investing heavily in the nearest account that is about to expire, it makes more mathematical sense to instead invest for the furthest account, since that better utilizes the potential future value of my current investment, and each account that expires sooner gets less amount of an investment. Since I already had that 2020 account, I just spread that among the first 3 accounts that will be cashed out first. This allows me to invest more heavily in the later 2 year accounts while not suffering paltry results in the near future.
These accounts aren’t as heavily invested as that first account was, because I’m now pivoting to experiment with the perpetual funding concept, but I still think this is a fun concept that gave savings more purpose.
How to set up this method:
While I did lay out the basics of this concept, it may still be difficult to figure out how to implement this. The first thing is to understand that it has pretty loose parameters, so there are many different ways you can set this up, but I’ll show one easy way to do this:
Step 1: open accounts.
Again you have plenty of flexibility here, if you don’t want to possibly lose some of your investment due to market corrections or entering another recession, you can just open up 5 savings accounts through whichever bank you use. But I recommend you just open an account with Betterment and just set up 5 different funds within the account and label them based on the intended expiration year: 2019 Fund, 2020 Fund, 2021 Fund, etc. Betterment creates a diversified portfolio and you can just do the standard 90% stock, 10% bond mix, but you could change the mixes based on how close to expiration that fund is. For instance the 2019 fund could be 50% stock and 50% bonds, this would then stabilize the account and it shouldn’t grow or lose value much by next year if that’s more comforting to you.
Step 2: Set up automatic investing
Once you have the accounts set up, determine how much you can afford to save, and then divide it by 30. To make this simple, let’s say you have $30 per week that you can save. By breaking it up into 30 pieces means you 30 $1 portions, and we’re going to divy them up amongst the 5 funds. For the first fund, (the nearest expiring fund), we’ll use $4 of that 30 towards that. Then for the next year, we’ll increase the portion by $1, so it’ll have $5 per week going to that fund. For each year, we’ll increase the portion by $1 so that the $30 is spread amongst the 5 years like: $4+$5+$6+$7+$8 = $30 total. All you have to do is now just set up automatic deposits based on these numbers (or multiply it by 4 and just make it a monthly deposit). Again you can do this however you want, but just have it in some way so that the furthest expiring account is getting more deposits than the nearest one.
If you have some extra cash sitting around, throw those in the first few accounts to give them a jump start. If you don’t, don’t worry, it just means the first couple of years the cash outs won’t be as lucrative, but each year should be noticeably larger than the previous.
Once you’ve set up the automatic deposit, you’re all set! Isn’t that surprisingly easy?
Step 3: Cash out funds
Once you’ve reached the next year and you’re ready to cash out, all you have to do is make the order to liquidate the account and the money can be deposited into your bank account the next day. What you decide to do with that money is all up to you. You can just have the money transferred to your checking account and you can spend it as you please, or what I recommend is opening a second checking account purely for this method of savings. Thus when you cash out that year’s savings, the money gets deposited into an account that is comprised of only this lump sum. When you decide to use this money to purchase something, you still have all the flexibility like with your other checking account, but being able to observe its separate balance may help you to enjoy the value it provides to you since you can eventually use it to splurge on something nice, and comes from this other account that isn’t connected to your daily finances, and thus you don’t even feel the pain of loss when you’re making the transaction. It definitely isn’t necessary, but it may be a nice mental trick for you. Also if you happen to not spend all the money that year, it essentially just gets rolled over once you cash out the following year’s fund, so you have this new lump sum plus the leftovers of last year’s fund.
Step 4: Recycle
Remember that since a new year means you get to cash out money, that also means you need to start another fund for what is 5 years beyond this current year. The easy thing to do is just rename the fund that you just cashed out as the new 5th year. But since each of these funds are no longer in the same relative position to each other, that means you just need shift the automatic deposit amounts down one year. Thus the original 5th year fund, the 2023 fund, is now 4 years away when we’re in 2019, it now needs to receive the amount that the 2022 fund was getting last year. The new 5th year fund of 2024 will now get the highest contributions.
And that’s it! If you keep this up, you’ll have a progressively increasing cash out every year forward that will have greater and greater impact on your life. I used my first fund to pay for student loans, but what about the fund I’ll be investing in over the next 5 years? Could that be enough for a down payment on a house? Since that is probably what people would hope for their savings to do, this method could create a constant influx of funding that allow you to make large purchases that may have been an impossibility previously.
I just wanted to share this concept because this is a great introductory step that can provide you with meaningful results, while not trying to establish an overly elaborate plan for your entire financial future; this just helps smooth your income out so you can maximize the usefulness of what you make. We know that savings and investing are good things to do, but these can seem like an impossibility unless someone sits us down and guides us through it, or that we have the financial flexibility to carve out some of our income. So I hope this can be a foot in the door that allows you create more financial flexibility, so that you can make even better financial decisions that further propel you further.