The Canadian Money Roadmap

The Three-Account Cash Flow System for Financial Stability

August 23, 2023 Evan Neufeld, CFP® Episode 95
The Canadian Money Roadmap
The Three-Account Cash Flow System for Financial Stability
Show Notes Transcript Chapter Markers

In this episode I lay out a simple 3 account strategy for managing your cash.  It doesn't get much simpler than this! 

This approach will make sure you have cash set aside for monthly expenses, future expenses and emergencies.


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Speaker 1:

Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, evan Neveld. Today's episode is really practical. I'm going to tell you all about my three-account cash flow system, so the exact bank accounts that you need to make sure that you know what you're going to do with your money when you get paid, how to save for upcoming expenses and how to make sure you never run into financial trouble with an emergency. Okay, this episode is going to be really quick and easy, but really practical, because I think I could do a better job at giving really practical tips instead of high-level concepts, and so this one is all about what to do with your money and how many bank accounts you should set up, and things like that. So I am going to advocate today for a very simple three-account system that you can use to make sure that all of your bills get paid on time. You have money for big expenses coming up in the future and you've got money set aside for emergencies in case things really go haywire. You can make it more complicated than this if that makes sense to you, but I think there's a lot of value in simplifying one's financial life as opposed to over-complicating. I've seen so many times where people have bank accounts and bank accounts and savings accounts all over the place. They have so many different things. This is a simple system that should work for the vast majority of people. So first things first. The thing that you need to get set up is your checking account. For those of you that are probably quite a bit younger than me, even you've probably never written a check before, but the language still remains a checking account. Essentially, all that this account is is your transaction account. This is where all of the action is. Money will get paid into this account and everything will get paid out of this account when you're paying your bills. Using a credit card for daily purchases and things like that is good, but your checking account is going to be your workhorse for a lot of the big transactions that are going to happen every month. I don't care where you have this checking account. I personally use one of the big banks. I'm not scared of working with any of the large banking institutions in our country. I know some people prefer smaller banks or some online banks there. I'm going to get to those in a second but for this checking account, I use one of the big banks. They typically have the most features and the best service, and if I need something in person, I can go talk to somebody. It's pretty rare that I actually need it, but when you do, it really makes a big difference. I needed that recently, and so it was nice to be able to go in and talk to someone for two minutes and then I was done. Every one of the big banks has a very low cost or even a free account that you can set up. This is not an ad for any of the banks by any means, but it can be very affordable and most of them have really high feature accounts with unlimited transactions, maybe a safety deposit box, some things like that. Those accounts would cost some money every month. For some people that cost is worth paying, but lots of banks. There are ways to avoid those costs and in some cases I think RBC. If you have a credit card and a savings account and a checking account with them, it's an account-based discount. If you have more stuff with them, they'll give you a bit of a deal. I'm less interested in that compared to other banks. I think TD has a deposit minimum, so if you keep a certain amount of money in the account, they just get rid of the fees. It's not a crazy amount of money it's a few thousand bucks but also the fees aren't that crazy. I know everybody hates paying bank fees, but if that amount of money is really moving the needle for you every month, there are other conversations that we need to be having. Anyways, there are ways to get around paying any sort of fees at the big banks, but I don't really care. I recommend you have a checking account and this is where you're going to set up your direct deposit. If you are employed, this is where all of your money goes. You don't have different checking accounts all over the place. Just have one checking account where all of your income will go into every month. Then, from this account, I would recommend that you set up as many auto bill payments as you possibly can. There are certain ones that I can't automate and, for whatever reason, I had a few to automation on payments, my thing, and I realized that I had a few in our household that we didn't have set up with auto pay until very, very recently. So, anyways, do a quick little audit and see if you're doing any needless work every month and see if you can set up auto payment for any bills coming out of this checking account. One feature that I would carefully or cautiously recommend for your checking account is overdraft protection. Overdraft protection I used to work at a bank briefly while I was in university and you get to see all sorts of things and if you're listening to this podcast I'm probably going to be speaking to people that are all sorts of different levels of banking knowledge and familiarity and whatnot. So I'll be careful here. But overdraft protection is kind of like a line of credit where, say, you've got $1,000 in your account and you accidentally spend $1,500. Typically speaking, the bank would reject that payment and charge you anywhere from $49 to $100 or whatever the fee is. It's crazy that the fee on insufficient funds is really really high because the bank has to process and reprocess all of your transactions or front the money and charge you later. Big hassle for them. They're going to charge you. It's expensive for you. So if you have overdraft protection in place, it's kind of like a line of credit that steps in if, in case, you accidentally spend more than what you actually have in the bank account. I say accidentally because I know a lot of people use overdraft protection like a line of credit. Please do not be one of these people, because overdraft protection is stupid, expensive and it's usually charged at like credit card interest rates and the interest is charged daily. Okay, so for every day that you are in your overdraft limit you are being charged interest for it Crazy expensive. But if you have an oops it can really save you a lot of money. It can still be cheaper because the fees and tab and oops not sufficient funds charge is crazier yet. So check with your bank to see what options are available for overdraft protection. You might not qualify for it, but most people typically will. At my bank I know there are two options. One is a paper month to have access to it and they won't charge you every time you do it. I hope I'm not speaking to anyone that's in this case. But if somebody is using their overdraft protection like a line of credit, yeah, a monthly charge would be cheaper, just on the access fee. The interest is above and beyond that. But in my case I have overdraft protection set up to be a paper use, so I only pay a fee if I ever use it and I say good enough for me If I'm in a situation where I didn't plan appropriately enough for me to use the overdraft protection. I shouldn't be complaining too much about paying a fee, and I think it's five bucks, so it's pretty small potatoes. So in my case I would recommend getting overdraft protection on a paper use just as insurance, just to make sure you don't have any accidental not sufficient funds charges, especially if you are setting up a lot of auto payment for all of your bills, because your money will be coming and going without you being involved, so there is a risk of you over allocating accidentally. Some people ask how much I recommend that you keep in a checking account. I say this really depends on your preference. I have some clients that really plan out their month like literally down to the penny, and I have other clients that will keep like $50,000 in their checking account and if it gets below that number they get really, really nervous. Everyone has different things in their life that leads them to believe certain things about money, and so I don't think it's appropriate necessarily for me to step in in that regard, because there's no right answer for this one. If your goal is to have enough in there to reduce the fees that you pay in the case of, say, a TD account. Sure, that's just fine, but try not to get too close where you're accidentally going to be bumping up against your overdraft protection there. Maybe a thousand bucks, that's kind of the target there. I don't really keep a ton of money in my checking account, just enough to make sure that my auto payment bills are covered every month, like mortgage utilities. I even do some charitable giving automatically every month and so that all comes out of there as well. So that's the first one. So that's the first account. It's a checking account. The next one I would recommend you set up is a short term savings account. If you're looking at a bank, it's just called a savings account. Okay, this isn't a TFSA, this isn't an RSP. There's no sort of branding here besides savings account. I would recommend this for the different things that you have coming up in your life but aren't month-to-month expenses. So these would be things that you'd save for, like annual expenses. So in some cases you might pay your property tax once a year, maybe vehicle insurance once a year, life insurance sometimes that comes up once a year. You might be on monthly payments for those too, but those are very common annual expenses that people have. Another short term savings thing would be if you're saving for vacations, if that's something that you like to spend money on, I would say every month, set aside a little bit extra money. Here's a little bonus complexity, if you want. I often will do vacations in the US, maybe once a year, maybe once every two years, and so having some US dollars on hand is nice. So I do my vacation fund in a US dollar account. So that's a different savings account that I have set up. But anyways, you could. You could do it that way if you like that. But a vacation fund is critical because vacations are so easy to overspend and it's the last place that you want to be cheap. So if you have some money set aside like we had a great time and we went to Disney World a few years ago and eating at the park and having a drink or things like that it's like it, man, it can really add up. But if you've pre-saved for it, you can spend without feeling guilty about it. It's awesome. So having a short term savings for a vacation fund is awesome. Other things in your short term savings account, one-off expenses that you can plan for. So these are things that are probably not going to be annual, but maybe once in a while, but you can kind of see coming Things like renovations, landscaping, maybe new furniture, stuff like that. That's many thousands of dollars but it's not coming up right away. I do not recommend you invest that money because adding risk to that part of your financial life is inappropriate. If you know you need the money on a specific timeline, risk is not your friend, and right now this is kind of the benefit of higher interest rates where, depending on your financial institution or bank sorry, that's a bit of jargon there financial institution, a bank, depending on what bank you use you might be able to actually make some money on your cash that's just parked there. So this is why I recommend that this short term savings is held at a different bank, because a lot of the big banks are not paying any interest. Even if they're calling it a high interest savings account, they're not going to. So what I use is one of the online banks that you've probably heard of before. The one that I use is a big sponsor, the Toronto Raptors. I'll keep them unnamed. I'll let you do the research there if you want. I just don't want to advocate specifically for anything. Most of the online banks that you see advertised are either backed by one of the big banks or credit unions here in Canada, so I'm not really too concerned about some of the banking issues it might have heard of in the US with anything like this. But because they don't have a lot of overhead or physical property that they need to pay for, their expenses are pretty low and they want to be competitive with the big banks, and so they will typically pay a high rate of interest. Another reason why I like to use a different bank for my short-term savings is that it's an out-of-sight, out-of-mind situation in a good way, right? So if I have everything going in and out of my checking account, that's kind of where the action is all the time, and then I transfer some money over to my short-term savings at a different bank, I'm not spending a lot of time on that app or looking at the balances there or anything like that, so it stays there and I'm less tempted to spend it on something that pops into my head or pops into my Instagram feed or anything like that. If you're anything like me, I'm sure that there's always something new that you could spend money on, and keeping yourself away from your ability to spend that money is really going to work in your favor. So having your short-term savings at a different bank will really help you keep your money out of sight, out of mind, and growing for the things that you know you need to spend money on and the things that are important to you but aren't coming up today or this month. The last account that I would recommend you set up is an emergency fund. This is different from your short-term savings, because these are four things that are emergencies. Going to Mexico is not an emergency. Buying a new TV is not an emergency. So I recommend this account also be held at a different bank, probably that same one as your short-term savings, but it's away from your checking account, because this is the please don't touch this and less it's absolutely necessary money. So this account I would recommend you set up your list of things that you've deemed in advance, the things that you would deem to be an emergency. Here are some options A loss of a job and you can't pay your bills because you don't have income that's an emergency. If you have a reduction in your hours, that's an emergency. If you have a medical emergency, so like you got a big dental bill, like. A lot of that stuff isn't covered by insurance, or things like eye care fewer emergencies there, typically, but if your glasses break and you didn't have any more coverage left, there could be thousands of dollars potentially, depending on how expensive your glasses are those kind of things that that aren't part of typical medical expenses. Maybe you've got a unique medical condition. We have to travel to see a specialist I know some people that have done that recently. Maybe even your Pat vet bills. Those can be really, really crazy, and so maybe make your list of things that you would deem to be important there. As far as accessing your emergency fund, another thing to keep in mind would maybe be a deductible on insurance. So say, you get in a car accident, yes, you have insurance, but you usually have to pay a deductible. All depends on your province here in terms of how much that would cost, but I would say, have some money set aside for that. This one seems to be like less of an emergency, but I think it's also worth maybe planning for, or thinking about, tax reassessments. This seems to happen way more often than it should, but when people file their taxes and they get a refund, it's like oh, fantastic, and they always spend the refund. I've strong opinions about that. But CRA has the ability to go back and look at your tax returns and double check and take a look and see. Wait a second, I don't think you guys actually filed all of your reported, all of your income, and in that case it could be an honest mistake, it could be something that was completely missed. But in that case you have to come up with the money to pay them back Now, or else they start charging you interest on that, and again it is. I believe interest is compounded daily on that and the rates are pretty egregious and you won't know what's coming until it's already there. So to come up with some money to pay off some situations like that, I would say that would be a fair emergency. To access your emergency fund, not really a specific dollar amount that you can plan for there. It's common enough that I'll mention it, but it's uncommon enough that it'll probably never happen to you. But anyways, those are some things that I think of with an emergency fund. Again, I recommend you do that at a different bank to get a little bit of extra interest on the money, because I hope that that money is parked there for a long time and you don't have to access it In terms of total amount that you should have in your emergency fund. It can be tough to build this up if you're just starting to save and invest and maybe things are tight every month. Start by doing your best to get 1000 bucks in there. That won't cover everything, but if you have a few months worth of expenses, so that would be things like your mortgage or your rent and any of the other critical expenses that you have, not total spending. So your total spending usually includes things like going out and buying things that you don't desperately need every month, and so I wouldn't look at your overall budget or your overall cash flow and save like three months of your income. Three months of expenses would be a lot, I think, for a lot of people, especially if you're typically employable and you have the right insurances in place, a lot of these things will be pretty short-lived or one-off. So start with getting 1000 bucks in there. A lot of rules of thumb say three to six months expenses. I think six months of expenses is pretty crazy in terms of a total amount to have an emergency fund. But different strokes for different folks. If that's something that you feel that you need. By all means go for it. You'll be in decent shape if you can afford to save that much cash. So I will kind of summarize here again my three account system that I recommend to make sure that all your bills get paid, all your short-term savings is accounted for and your emergencies are covered. Start with your checking account. Have this at the bank of your choice. This is where all of your income goes. All of your bills get paid out of. Make sure you take a look at the overdraft protection options. If you can do a pay-per-use, that would be great. The second account that I would recommend is a short-term savings account. Again, the language at your bank will just be savings account, in some cases maybe even high-interest savings account. Whatever, you can compare different banks and try to get an account that has a fair interest rate compared to what other options are available out there. But do this at a different institution or a different bank than where you have your checking account. It'll just keep you from tapping into that money inadvertently or regretting it later. And the last one is your emergency fund. Do this at the same bank as your short-term savings and when you set this up. Just make a list, even a mental list, for yourself of just some of the things that you would encounter where you'd be willing to access this money. It is not your vacation fund. This is not the splurge on Christmas fund. It's just for emergencies, for the people that use their line of credit as an emergency fund. Your finances better be in spectacular shape before you consider this as your emergency fund, especially now when interest rates are so high, because when you're in an emergency and you borrow against a line of credit and it costs you over 8% now or whatever crazy number it is, that is starting to get to be the point where it'll be tougher and tougher to pay that off when you're no longer in an emergency because it's so expensive and the interest keeps growing and growing. So won't get into that too much here. But anyways, that is my quick and relatively simple three-account system for managing your cash flow. What do you think? Is it too simple? Is this still too complicated? What do you do? I'm curious to see what other people do when it comes to their cash flow every month. Let me know my emails in the show notes Hello at evannewfieldcom. Thanks so much for listening and we'll see you next week. Thanks for watching.

Three-Account Cash Flow System Setup
Setting Up Different Bank Accounts Recommendations
Managing Cash Flow and Emergency Funds

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