Create a Money Management System That Works! (Updated 2022)
This won’t come as a surprise, but I’m passionate about personal finance. But it wasn’t always like that for me. At the beginning, I did not have a money management system that helped me achieve my goals.
I used to have no clue about the basics of personal finance, such as budgeting, and retirement planning. Moreover, I had no idea how I would pull it all together and create an effective money management method that would help me achieve my financial goals.
Since there are a ton of things you can do to improve your financial situation, how do you get started without getting overwhelmed? The trick is to just use what you need when you need it, and then “level up” when you are ready.
Contents
What does leveling up mean?
As I began my journey towards financial recovery, I started to notice some unexpected benefits along the way. For example, once I had six months of savings to fall back on, I started to perform more confidently at work.
It’s amazing what you can do when your decisions aren’t driven by fear or desperation. This ultimately resulted in a promotion and pay increase.
It reminded me of some of the video games I’ve played over the years, where you unlock new abilities each time you make it to the next level. The game gets easier over time as you add tools to your arsenal.
This is also 100% true in personal finance. The more you “level up” your money management system and money management skills, the more easily you can get to the next level.
Don’t worry…I won’t go overboard with the metaphor, but you’ll have to indulge me a little!
So that brings us to what we’ll cover in this guide:
- An overview of the effective financial management system I use
- How to build your own system, one level at a time
- The value you will gain along the way
- Tools you can use to make it all much easier
Let’s dive in!
My money management system
A good money management system is really its own little ecosystem, with different pieces that all serve a specific purpose and work in coordination with each other.
At the highest level, money all flows in and out from the exact same place, my primary checking account. From there it flows through different levels, each with their own purpose and benefit.
Once you maximize the benefit of one level, you can move on to the next. The beauty is you only focus on one thing at a time, and once you have a level nailed down, you just build on it.
Let’s take a look at what’s happening at each level.
Level 1: Establish a primary checking account to manage all income and expenses
What happens at this level:
This is the foundation of your money management system. Think of it as the main pipe for all your income and expenses to flow through; every paycheck and bill should hit this bank account at some point.
If you’ve tried to juggle multiple checking accounts and credit cards for this purpose, you know how time-consuming and misleading that can be, since all those accounts likely update at different times on different days.
What benefit you get:
The benefit is simplicity. You’ll have one checking account to look at, and from there you can easily see when and where your money is going.
If you’re married and using separate accounts, this is a great opportunity to combine those financial accounts.
When you should level up:
Today.
Multiple bank accounts? If you have multiple bank accounts, figure out which one works the best for you and set it up as your primary.
Are you married? If you are married but banking separately, this is a great opportunity to address a common money mistake.
Using credit cards? If you are using credit cards for expenses (and assuming you are debt-free otherwise), consolidate your spending onto one card.
Just make sure to pay the entire statement balance every month before the due dates to avoid paying ridiculously high interest rates.
Power-ups:
Using a budget at this level will make it much easier to progress. It will let you start paying yourself first, which can quickly increase your savings rate.
If you want to go even faster, freeze the credit card (literally put it in your freezer in a block of ice) and use a tool like an envelope system to manage your budget.
By taking a close look at your spending habits, you may find that a lot of money is going towards things that aren’t important to you. And the best way to level up quickly is to keep track of your finances so you have a clear understanding of where your money is going.
Level 2: Save $1k in a resiliency fund. Connect this to your checking account for overdraft protection
What happens at this level:
Now that your income and expenses are all flowing through one pipe, it’s time to establish a financial buffer known as a “resiliency fund.” This is a saving account, funded with $1,000, that is connected to your checking account for overdraft protection.
This will give you a little bit of a cushion to help you avoid late fees while you’re working to get out of debt. If you need to dip into your resiliency fund, make sure to refill it ASAP.
What benefit you get:
Breathing room and time to think. When an unexpected expense comes up out of the blue, this account will allow you take care of it without impacting your personal finances or detracting from your long-term financial goals.
When you should level up:
Once you’ve completed Level 1 and have saved up $1,000 to fund your account. You may spend a lot of time here until you have a solid spending plan.
You might not have a lot of money at your disposal, but any small monthly contribution will help.
Level 3: Save 3+ months of expenses for your emergency fund
What happens at this level:
It’s time to create an emergency savings account where you’ll save 3-6 months’ worth of living expenses, ideally with a different bank than where you have your primary checking and resiliency fund set up.
This new account will be your emergency fund, and it should only be used in case of true emergencies, like a job loss.
Some people define “emergency” a bit loosely, so putting this money in a separate bank is intended to make it a bit more difficult to dip into. If you think of this as a financial freedom account, that might be an easy way for you to avoid those variable expenses from creeping up on you.
What benefit you get:
Peace of mind and confidence. Now you can weather some significant financial storms, which moves you from being in a defensive position.
No one wants to get fired, but now it’s not the end of the world if that happens. Or if a family member gets sick, you can focus on getting them healthy instead of worrying about the financial impacts.
When you should level up:
As soon as you have your resiliency fund in place, you should focus on paying off all non-mortgage debt.
Power-ups:
Some folks get a little antsy about putting so much extra money in a saving account that only makes around 1% every year.
While the point of this level is to not make too much money, you can do a little better than 1% by creating a CD ladder, which basically puts your money in higher return CDs. This is a very similar concept to bond ladders, which use government or corporate bonds to achieve the same goal.
These CDs are then staggered over multiple years to increase your return and reduce the small penalty you’ll have to pay if you end up cashing them in.
Level 4: Contribute at least 15% to tax-advantaged accounts
What happens at this level:
Let the retirement planning begin! Assuming you debt-free and have your emergency fund in place, it’s time to contribute to any investment accounts you’ve been ignoring.
This could be through a number of financial accounts like an IRA, 401(k), 403(b), TSP, etc. You’ll want to get your contribution up to at least 15% of your income, if not more.
What benefit you get:
Comfort and confidence that comes with knowing you have a plan for the future. No one wants to have to work forever, though some may choose to because they love what they do.
At this level, you are putting a stake in the ground that says you will be able to retire someday. It’s a good feeling to have financial security.
When you should level up:
Once you are out of debt and have an emergency fund in place. If you start sooner than that, you risk staying in debt longer and having to tap into your retirement account in case of an emergency.
Power-ups:
You’ll need to decide whether you want to use a Roth or Traditional retirement account. The primary difference between the two is when you pay taxes, either now or when you withdraw funds during retirement.
If you have a 401(k) with an employer match, their contributions will always go into a Traditional account, so if you sign up for a Roth, you’ll effectively have both.
Level 5: Set up goal-based savings accounts for vacations, house down payment, etc
What happens at this level:
At this level, you can open individual savings accounts for goals. These can be short term savings goals or long-term goals with specific purposes.
Many banks will let you do this, so I’d check with whoever you have your primary checking account with. Each account should be for a specific short-term goal, like vacations, Christmas shopping or a down payment on a house.
If you have a child and want to start saving for their college, this is also when you’d set up a 529 account for that purpose.
What benefit you get:
Stress-free fun! Vacations are awesome, but coming home to a pile of bills isn’t. Why not reduce your post-vacation blues by saving up a few thousand dollars a year so you can pay for your trip in advance? The same goes for the holidays.
Christmas shopping is a lot more fun if you’ve already set aside money to pay for all of those gifts. You’ll also likely see that your credit score has started improving from all of the financial success you’ve been having.
When you should level up:
Once you are contributing at least 15% of your income to retirement investing, and assuming you are debt-free.
Power-ups:
I can’t stress enough how easy this is if you have a bank that allows you to open different accounts.
Level 6: Open a brokerage account to pile up cash in ETFs
What happens at this level:
It’s time to start dreaming big with your money management system! For me, this means building enough wealth that I get to choose what I want to do and when I want to do it.
The first step in that is creating a war chest of money to invest in other wealth-building assets. I use a brokerage to invest in no-fee ETFs that index the S&P 500.
Because I’m a personal finance nerd, I also have a robo advisor that invests for me as well, so I can see how my personally picked investments perform as compared to the robots.
I suggest not touching anything in this account for at least 5 years. That way your money isn’t as impacted by the volatility of the stock market.
What benefit you get:
Ever-increasing net worth and the options that it brings. This is really what wealth provides…the more money you have, the more options are open to you.
When you should level up:
As soon as you are done with Level 4 (retirement planning), you can technically go directly here. That said, I would encourage you to not skip Level 5–you’ve made it this far, so enjoy your life and treat yourself to a little stress-free fun.
Power-ups:
There are a ton of no-fee ETFs that can help you save a bunch in the long run. I’ve used iShares from Blackrock myself.
It also wouldn’t hurt to use a robo-advisor if you want to be hands-off here. If you’re looking for some options, personally, I’ve really enjoyed my experience using Wealthfront.
Finally, Personal Capital is one of the best personal finance software companies out there. Although they have professional finance teams of advisors to help people with their investments and financial planning, their digital technologies are great for helping people paint their own picture if they choose to work on their own.
Level 7: Invest opportunistically in income-producing assets and reinvest the gains
What happens at this level:
Diversification, diversification, diversification. This is when you start really getting into the coolest parts of personal finance, building passive income streams that may provide financial freedom someday.
In my case, I diversify into three different cash flow streams: real estate, dividend investing, and small business.
I fund these directly from the war chest I created earlier. Any income produced gets reinvested or flows to the top and gets deposited in my checking account, closing the loop on my money management system.
What benefit you get:
For me, early retirement is a big dream, so this level is focused on making that happen by creating enough wealth that I can pursue it. You may have other big dreams in mind, which this level can help you make a reality.
When you should level up:
Don’t rush to do this. Take your time piling up cash in your war chest, and be very opportunistic in how you spend it. If you want to buy a rental property, pay cash and wait until you see a steal.
Because you’ve already built up the funds, and you’re already saving for retirement, you can afford to wait for just the right opportunity.
Wrapping up
So, there you have it. That’s the money management system I use, and how I built it level by level. From start to finish, it took me about three years to get to Level 7, which felt like it went by in a blink of the eye once I got rolling.
What other “levels” do you have?
How else have you made managing money easier for you? Leave a comment below!