The Two-Account System for Automatic Savings

Millie writes in, describing her interesting system of making herself save:

I have my paycheck direct deposited into ING Direct. It comes in like clockwork on the first and third Friday of each month. Then, on the 10th and the 24th of each month, ING automatically transfers about 60% of that paycheck amount directly into my main checking account. I then proceed to live on what’s in my checking account.

Once every few months, I’ll go to ING Direct and do various things with the money. I usually transfer most of it into an investment account – the rest goes to replenish my emergency fund or help with some other short term savings goal.

This really works for me. I hope you share it with your readers.

I think this is a brilliant method for making automatic savings work. It strongly enforces the idea of “paying yourself first” – meaning that personal savings is the highest priority with your money. It forces you to learn how to budget with what you have – if you naturally live paycheck to paycheck, this really enforces some discipline on your financial life. You can throttle it back and forth however you wish – the less you automatically transfer from the savings, the more you will be able to save up for emergencies, debt repayment, and other savings goals.

If a person sticks with this plan over the long haul – no cheating and no dips into the emergency fund for non-emergencies – they can get ahead financially. The smaller the percentage of their paycheck that they transfer, the better off they’ll be.

Understanding the Two-Account System

How it Works: An Example

Let’s say John brings home about $400 a week. He realizes that with some discipline, he can live just fine on about $300 a week – so he decides to try it out. He signs up for an online savings account, has his paycheck automatically deposited into that account, then sets up a weekly automatic transfer that triggers a few days later to transfer $300 into his main checking account.

John scrimps a little bit – taking on a few cash odd jobs, living lean – but he makes living on that $300 a week work. Halfway through the year, he gets a raise at work – now his paycheck is $425 a week, but he doesn’t change a thing about his savings plan.

At the end of the year, John has about $5,900 in savings. That’s enough to write a check for a fairly reliable car. That’s enough – with another two or three years of this – to have the down payment on a decent home. That’s enough to pay for some night classes or, in a few years, pay for a couple years of schooling leading to a bachelor’s degree.

For a person bringing home $400 a week, $5,900 can be “change your life” money. And all it takes is a year.

Switching to a Two-Account System

This system isn’t too hard to set up, either. In fact, I use my own (overly complicated) version of this system to manage my own money.

1. Start living leaner right now

You’re going to need to build up at least a little bit of buffer in your checking account, because there will be a period where you almost “skip” a paycheck. You’re not really skipping a paycheck, but this system means you’ll start receiving your paychecks about a week or so later than you used to. Thus, you will need some extra cash. Plus, you’ll need to live a bit leaner in order to survive on the smaller “paycheck” that you’ll get.

I usually recommend that people start by trimming some of the obvious fat, particularly through one-time actions. Look through all of your bills and see if there’s anything you can cut – premium cable, excessive cell phone plans, and so on. Work on improving the energy efficiency of your home.

2. Look at your regular expenditures

3. Sign up for an online savings account

I use ING Direct and I’m very happy with them, but there are a lot of options out there. An online savings account has the advantage that you can easily manage it at your own computer and also that it earns a solid interest rate.

The real advantage, though, is that it creates a wall between your savings and your spending. With an account at a bank completely separate from your primary bank, you can’t just stroll in and make a big withdrawal on a whim. Instead, you have to log onto your account, execute a transfer, then wait a few days for that transfer to clear both banks. That waiting period gives you time to really think through your decision and it will often convince people that they shouldn’t go through with an unnecessary expenditure.

4. Change your direct deposit at your employer to your new bank

It’s during this period that you’ll have to live lean and pay careful attention to the process, because the direct deposit may not necessarily arrive at your new bank at the exact same schedule as your old bank. Watch your new account carefully to see when the deposit comes in.

Once your first paycheck is in the new account, set up your automatic transfer from the new account to your old checking account. You have a lot of options as to how to set this up.

For one, you can match your current payment schedule – only a few days later – and simply transfer a bit less than you bring in. So, if you have a paycheck that comes in every week for $400 on Fridays, you can have a transfer the following Tuesday or Wednesday for $350 to your checking account. This will leave behind $50 each week in your account, which will really build up.

5. Slowly spread out your paychecks

For example, if you’re paid every two weeks (26 times a year), you can have the transfer happen on the 1st and 15th of each month for the amount of your paycheck – $400 – which would be 24 times a year. This would leave behind the two “extra” checks you get each year – a total of $800.

Or you can do both. If you have a weekly paycheck that’s $400 (52 checks a year), set up four transfers a month at $350 (48 transfers a year). This leaves behind $50 each time you make a transfer – a total of $2,400 over a year – plus the extra four checks – $1,600 a year – for a total savings of $4,000 over the year.

The key is to make sure that you’re transferring less than you bring in. How exactly you do that is up to you, but the purpose of this is to make sure you’re leaving behind some savings in the account. If $10 comes in, less than $10 should be going out.

Once the first transfer comes through from your new account to your old account, you’re good to go. The system is in place – you can largely forget about it. I recommend not changing anything if you get a raise – let that raise go entirely into savings. Instead, only make a change if you’re sure it needs to happen in your life. If you find yourself actually spending substantially less than you’re getting into your checking, lower that transfer a bit. If you’re struggling to make ends meet and you’re not wasting money, don’t be afraid to bump it up a little.

Good luck! This is a great plan that can really help kick your savings into gear.