Safety in financial world is an oft-repeated word, and is mentioned in contrast to risk and growth.
We talk a lot about risk-return trade-off, safety of invested principal in long term and short term investments.
There is another way of looking at Financial Safety. The SAFE plan described below is a way of setting up financial life that is SAFE by design, not in the traditional sense of Safety vs. Risk but automatic habits that ensure you don’t stray from common sense.
Common Sense and Simplicity in Financial Plan is hard to achieve. True it is counter intuitive, but most people land into financial trouble due to complicated behavior – be it spending recklessly, chasing high unrealistic returns or simply throwing caution to the wind.
The SAFE Plan
Let me first present the 7 steps to SAFE plan.
- Invest in pre-tax accounts like 401k and HSA.
- Set up a direct deposit of the remaining taxable income to a checking account.
- Set up credit card payment to be auto paid from the checking account on the 30th of every month.
- Set up an auto-invest plan where 10-20% of the taxable income is diverted to a brokerage account or another IRA account (like Roth IRA).
- Spend your monthly expenses on the credit card. Keep an eye on the credit card balance with the money left over in the checking account.
- Save the left over surplus, if any.
- Continue and repeat next month …
The above steps are nothing new. They have been suggested by numerous financial coaches and gurus. However the importance of the SAFE plan is how the steps are stitched together and flows through a seamless automation.
Since we have established the Simplicity of the SAFE plan, lets look at the Automation part and how to set this up.
- You just need to figure out the % you want to put in 401k or HSA, and inform your payroll department. This can be decided based on the following factors.
- Your cash flow needs after this deduction.
- How much to invest to capture any employer provided matching contribution.
- Max limits of the 401k or HSA.
- Direct deposit of the taxable amount to checking account.
- This is handled by your payroll department automatically.
- Setup credit card auto-pay from your bank account for the 30th of every month.
- This one if not done, can prove to be dangerous as missed payments are very costly.
- The trigger will also help you pay-off something even if you have amassed a debt.
- You can configure to pay off the entire balance, minimum payment or a fixed amount.
- Setup auto invest for 10-20% of the taxable income. The exact % can vary as it will depend on your household expenses.
- Even if your budget does not allow this today, find at least a small amount ($50-$100) to divert automatically to an investment account.
- This will build the habit and set you up for regular investment.
- The amount can be increased over time as the budget frees up extra cash.
- Live within your means. This is again a cliche, but very difficult to be consistent month after month. You can manage it with some automation and discipline though.
- setup a notification when your credit card balance crosses 90% of your projected expense for the month (or simply the money left in the checking account).
- Put a Level 5 tornado/hurricane warning when it is crossing over the money left over in your checking account.
- Typically the projected expenses can be simply set to the money left over in your checking account. You cannot spend more than that without incurring consumer debt or dipping into other savings/investments.
- Save the surplus – If you have surplus at the end of the month (that is, Credit card balance < Money in checking account) you can save it for future goals, short term and mid term.
- I wish banks provided this facility, but it can be set up to transfer a fixed amount once you have an idea of your monthly expenses.
- Some apps like Acorns or Digit automate this although in more complicated way.
- Do not leave the money in the checking account otherwise next month it will create an illusion that you can spend more.
- Let the automation run month after month.
Once setup correctly, the basic version of the SAFE plan is low maintenance and enables an almost debt free living.
Of course, we have not taken into account mortgage payments, prior debt pay down, saving for education – but these can also be fit into the plan. In the step where you are investing 10-20%, you will break that into smaller chunks of various debt pay down and remaining amount can be invested for various goals.
Thus the plan is also extremely flexible to adapt to individual situations.
The last part of the SAFE plan is that it is efficient in managing money.
The following good principles are built-in into the plan.
- Pay Yourself First – Pre and Post Tax investments are deducted in the beginning.
- Low maintenance – no coupon cutting, daily budgeting etc.
- Keeps you debt free – just keep tab that your credit card balance is below money left over in checking account.
- Encourages more savings at the end of the month – creates a healthy race to increase it, by reducing your spending.
The efficiency is evident if you do this for even one year. You will see the difference in your credit score, savings balance, net worth and above all, peace of mind.
This plan has been working for me for a long time. The simplicity and automation helped me manage it seamlessly without getting distracted from my main job – which is not finance.
And the in-built savings and investment discipline in the plan has helped me invest and accumulate cash for emergencies, short term purchases or just a cash cushion.
Here is my version of the 7 steps of the SAFE plan (the % are approximate and rounded)
- Invest some in the Roth-401k and H.S.A.
- Direct deposit first paycheck. (50% of monthly)
- Use the credit card from same account. Set up auto-pay on 30th of every month.
- Investments/Pay downs
- 10% to mortgage account
- 10% to savings for property taxes, insurance and maintenance
- 20% invest in mutual funds via brokerage account
- 10% to a 529 Plan
- Next paycheck direct deposit on 15th of month. (50% balance monthly paycheck)
- Living expenses capped to 40-45% of monthly total.
- Pay off credit card balance within this limit – I make sure it is $0 as it enters following month.
- Sometimes it is hard to stick to the limit, then I have the cash cushion (from previous months’ savings, step 6) to dip into.
- 5-10% savings for vacation/travel, fun, cash – diverted to a high-yield online savings account.
- Keep track every Saturday morning using Y.N.A.B.