High-Yield Savings Accounts

ben_franklin_2There are (at least) 3 different kinds of savings accounts at credit unions and banks.

  • Regular or Basic Savings.  Used to be called “passbook” savings accounts.  Low minimum balance requirement.  Allow an unlimited number of withdraws, which may be made at any time.  Pay the lowest amount of interest.
  • High-Yield Savings.  Limited number of withdraws, but withdraws may be made at any time.  Pay higher interest (but not as much as certificates of deposit).
  • Certificates of Deposit.  “CDs” or “time deposits”.  High minimum balance requirement.  No withdraws until after a specified time (months or years).  Pay the highest interest.

If you’re keeping all of your emergency savings and other savings accounts in a regular savings account, the value of your savings is decreasing as inflation takes its toll.

You savings could be earning a higher interest rate if you put them into certificates of deposit, but then the money won’t be immediately available to you if you need it to take care of an emergency.

A high-yield savings account, which combines the best features or basic savings accounts and CDs, might be just right.  You can make withdraws whenever you want (but you are limited to a certain number of withdraws per month), but at least you’re getting some interest that will offset the effects of inflation.

Search the internet, and you’ll will many banks offering high-yield savings accounts.


A $1,000 Emergency Fund Savings Account: One Thing Dave Ramsey is Right About

I don’t mean to imply that Dave Ramsey is wrong about a lot things.  Generally, his advice is very good, although it does tend to be a bit simplistic and one-size-fits-all.  And there is a raging debate about paying off debt using the “debt snowball” method he recommends.  But if there’s one thing that he gets 100% correct, it’s his “Baby Step Number One”, setting up an Emergency Fund savings account getting $1,000 in it.

Emergencies are certain to happen.  Anything mechanical — such as a car, washer, dryer, furnace, air conditioner, water heater, oven, dishwasher, etc. — can break down.  Roofs can leak.  Pipes can leak.  Computers crash and die.  Pets need veterinarians.  People need doctors.  Or lawyers.  Or bail.  It’s not a question of “if?”, it’s a question of “when?”.

$1,000 might not be enough to take care of every emergency.  Some emergencies will cost a lot more.  But $1,000 will take care of a lot of the emergencies that will come your way.  Even if it’s not enough, at least $1,000 is a start.

If you live paycheck-to-paycheck, if you earn just enough each month to pay your predictable bills and you have nothing saved in an Emergency Fund savings account, then you are unprepared for anything unpredictable … and “unpredictable” is part of the definition of “emergency”: an unforeseen combination of circumstances or the resulting state that calls for immediate action.

Maybe you think you can just use credit cards.  Big problem: If you have no savings, and all of your income in a normal month goes to pay that month’s predictable non-emergency expenses, then you won’t be able to pay off the credit-card bill when it comes due the next month.  That means the credit card will start charging interest — effectively increasing the cost of your emergency.  As if the emergency itself isn’t costly enough, you want to add to it?  If you can’t pay the minimum amount due on that credit card bill, then you’ll have compound interest working against you.  This is bad.  (Hint: compound interest should be working for you, not against you.)  Also a problem: The banks can say “no” at any time, cancelling your card or reducing your credit limit as they see fit.  When it rains, it pours, right?  This also holds true for using a home-equity line of credit.  If you’re living paycheck-to-paycheck, how are you going to pay back a home-equity loan?  And again, you’re at the mercy of the bank: The bank can reduce or eliminate your home-equity limit at any time, and are likely to do that if you’re unemployed or if the economy shows signs of recession.

The smart thing is to be prepared.  Now.  Open a savings account at your credit union or bank and start putting something into it — $100, or $75, or just $50, or whatever you can — every time you get paid.  Pay yourself first: Put that money aside before you spend any of your take-home pay on anything else.  If you get paid twice each month, $50 from every paycheck will get you to your initial goal of $1,000 in less than a year.  If you can set this up to happen automatically, so much the better.  Keep putting that money into the account until you have at least $1,000.  As you savings grow, you will enjoy the sense of well-being and security that comes from having a little something set aside.  You will sleep better at night.  One less thing to worry about.  You can take care of a $1,000 emergency!  As it says in The Richest Man in Babylon, “Soon ye will realize what a rich feeling it is to own a treasure upon which ye alone have claim.

keep_calmOnce you have your $1,000 Emergency Fund, make sure you don’t use it for anything except a genuine emergency: an unforeseen combination of circumstances or the resulting state that calls for immediate action.  Don’t give in to any temptation to spend it on anything else.  Once you have met your goal of saving $1,000, it’s time to set yourself a goal of having $2,000 at the ready.

Sooner or later, that unforeseen combination of circumstances or the resulting state that calls for immediate action, i.e., the immediate spending of money, will happen.  When it does, don’t borrow money by using a credit card.  Instead, you “borrow” from your own emergency savings.  Spend carefully, but take care of whatever needs taken care of.  Then, as soon as you are able, you “pay it back” by making your usual deposits to your Emergency Fund every time you get paid, building it back up to where it was before the  emergency, and then beyond that.

If you don’t have an Emergency Fund, why not?

If you think you can’t save $1,000, then think again!

You can work more.  Work more hours.  Get a second job.  Mow grass.  Wait tables.  Flip burgers.  Whatever it takes, get that money into your Emergency Fund.

You can spend less.  Get a cheaper cellphone plan.  Cancel your cable.  Don’t eat anything you didn’t buy at a grocery store and cook at home.  Whatever it takes, get that money into your Emergency Fund.

You can sell some stuff.  Downgrade to a cheaper car.  Turn some unneeded clothes into cash.  Clean out the whole house and have a yard sale.  Whatever it takes, get that money into your Emergency Fund.

The four paragraphs above are very important.  Saving money and putting it into an Emergency Fund isn’t just a good thing because it prepares you to better handle an emergency.  It’s also an exercise in living below your means, spending less than you earn.  You know, “Do not save what is left after spending; spend what is left after saving.”  Imagine your income is water flowing into a tank and your spending is water flowing out.  If the water flows out as fast as it flows in, the tank will never get full.  No matter how high the income, people who spend all they earn — people who are unable to live below their means — will never have wealth.

The same thing that builds your emergency fund is what will build your net worth.  If your net worth is negative (your debts are greater than your assets), then spending less than you earn will allow you to pay off those debts.  If your net worth is zero or not much more, then spending less than you earn will allow you to save and invest.  Remember, the Emergency Fund is the first step.

I Don’t Want to Charge Anything (I’m Just Here for the Bonus)

Credit-card churning.  Is it for you?

credit_card_offersThese days, many credit cards come with a sign-up bonus for just applying for and getting approved and then using the card by charging some minimum dollar amount within a certain period.  For example, charge $500 within the first three months and get a $150 bonus.  Some cards will apply the bonus as a statement credit, some will send you a check.  Others give you the bonus in rewards points or airline miles, instead of money.  (Note that this sign-up bonus is separate from earning some percentage, say 1% or 2%, of your total charges in miles or rewards points.)

Credit-card churning is defined, basically, as doing everything you can to get as many credit card sign-up bonuses as possible.  This means signing up for lots of credit cards, spending just enough (but no more than necessary) to get the bonus, then putting the cards aside and eventually cancelling them.  Of course, you have to pay off everything you charge, but that shouldn’t be a problem if you only charge things that you would normally buy anyway.

The problem of course is meeting the minimum spending (i.e., charging — which actually means borrowing) requirement in order to qualify for the bonus.  Buying $500 worth of stuff you don’t need in order to get $150 doesn’t make you better off — just the opposite, you should avoid that like the plague!  But if you can charge the required amount by just spending what you normally would on things you have to pay for anyway, … then it’s a lot more like getting $150 (almost) for free.  (Of course, there’s the cost of your time and trouble and maybe some fees for using a credit card for certain purchases.)

This is where credit-card churners get creative.  Instead of going on a spending spree, the successful churners use their new credit card to buy their ordinary purchases such as groceries and gasoline.  Another way to accumulate the charges necessary to get the bonus is using the card to pay for things like phone, internet, cable, electricity, natural gas, and water and sewer services.  You might be able to pay for your car insurance with your new card.  Perhaps you can pay some small monthly bills, such as video or audio streaming services, in advance by paying for a year of service instead of paying monthly.  Local taxes (such as property taxes, vehicle registrations, etc.) might be credit-card chargeable.  Some credit-card churners even pay their rent or mortgage with the new credit card, though doing this requires some additional effort (see below).  All of these can be done online; the bonus wouldn’t be worth it if the bill paying couldn’t be done  just sitting in front of your computer.

It may or may not be possible to pay your utility bills with a credit card — whether these service providers take credit cards varies from place to place.  If you’re going to be a credit-card churner, you need to do some research.  Also, unlike using a credit card at a grocery store or gas station, you might be charged an additional fee to pay for things like electric, natural gas, and water service with a credit card.  Likewise for your property taxes and vehicle registration.

The easiest way to get up to the spending minimum is to put your rent or mortgage payment on the card.  In the past, landlords generally didn’t accept credit-card payments (after all, they have to pay a fee to the credit-card issuer and it’s not as if you’re going to buy more from them if you can put it on a credit card the way that restaurants and shops hope you will splurge when you’re not spending cash).  However, many landlords now accept credit cards for the convenience of their renters, but they pass the fee along to the renter.  Mortgage lenders pretty much never accept credit cards, at least as far as I have ever heard.  But now — the internet to the rescue! — there is a company called Plastiq that will allow you pay your mortgage (or just about anything else, … your university tuition, your utility bills, etc.) and charge it to your credit card.  You sign-up on their website, give them the name and address of whoever you want to pay, they send a check to whoever you so designate and they charge your credit card … and tack on a fee of up to 2.5% to cover their costs and make a profit for themselves.  2.5% of $500 is $12.50.  (Btw, here’s a link you can use to sign up for Plastiq.  If you click thru and sign-up you might be able to pay a bill via Plastiq for a reduced fee and I’ll get similar reward too.  If you sign up for Plastiq, I thank you.)  You need to decide: Is the credit-card churning bonus worth it if you have to do the work of setting up these credit-card payments and you have to pay $5, $10, or $15 in fees?  So ask yourself: Is it worth paying that to get your bonus?

Of course, it helps your bottom line if you avoid interest charges in addition to avoiding paying fees just to use the card.  In fact, if you rack up too many fees and interest charges, you might entirely offset the bonus.  Many new credit cards include an interest-free period during which 0% APR (annual percentage rate) is applied to your purchases; this interest-free period might last 6, 9, or 12 months, maybe longer.  Some credit cards come with an annual fee on the card itself.  In some offers, this fee is waived for the first year, but might be around $100 every year after that.  Check the details before you sign up.  You must read the fine print.  Carefully.

My experience: Over the past several months I’ve signed up for 4 credit cards that came with a sign-up bonus.  Three gave me a $150 bonus (or points worth $150) for charging $500, the fourth was a $200 bonus after charging $1,000.

  • With the first card, I used Plastiq to make an additional payment to my Bank of America mortgage.  Everything went perfectly.  BoA got the check for $500 from Plastiq and I got a $150 check from the card issuer.  I usually throw an additional $500 or so above the required payment towards my mortgage balance each month, so this is just normal spending.  However, as an added benefit, I can pay off that $500 over the next 10 months at 0% interest.  I put my check into my emergency savings account.  Kind of financial poetry, that I will be able to use that money to take care of some future emergency instead of putting it on a credit card.  Adding money to my emergency savings for just making an additional payment to my mortgage as I usually do … that’s good!
  • For the second card, I more than met the spending requirement by paying for a medical procedure.  This wasn’t exactly normal and typical spending, but it was something that was definitely necessary.  Some weeks later I got a statement credit which reduced the balance by $150.  I paid off the remaining balance during the zero-interest period.
  • I used the third card to pay my electric, water + sewer, natural gas, phone and internet, and car insurance bills (but I couldn’t use it to pay my cable bill, because I don’t have cable!).  The fees required to pay by credit card were lower than Plastiq’s usual 2.5% fee.  In order to get to the bonus level, I paid the electric bill for the current month and about the same amount in advance; this didn’t cost any more in fees, because the fee was a flat amount regardless of how much I paid with the credit card.  As soon as these totaled $1,000, I got a statement credit, which I used to buy groceries.  In essence, a free cart full of groceries just for spending money as I normally do.
  • I used the fourth card for groceries, clothes, and some Christmas presents.  For that one, I transferred the reward points I accumulated to my Amazon account, which allowed me to purchase $150 worth of food and household supplies, some tools, and a clock radio.  $150 for me for just spending money as I do normally.

Overall, I’m quite happy I’ve done this.  I’ve “earned” $600 for “work” that took about an hour or so and was mostly just doing what I would have done anyway.  To my way of thinking, it was very much worth it and I look forward to doing it more, just as I like opening checking accounts to get bonuses.

However, there are some downsides and considerations …

Temptation.  The only to win at the credit-card-churning game is to get a credit card, use it just enough to get the bonus by charging things you normally buy, then stop using it and eventually cancel it.  The sum of the credit limits on the 4 credit cards I got recently totaled about a quarter of my total annual income.  I could have used those cards to go on a cruise, fly off to a tropical-island resort, and gotten new furniture, TVs, and stereos for every room in the house.  That’s exactly what the banks want you to do.  Of course, I didn’t because that would mean compound interest would be working against me, making me a slave to credit card companies.  But if your financial discipline is not sufficiently stalwart, you shouldn’t have any credit cards, let alone credit cards you don’t need.  If you can’t trust yourself to resist the temptation to use the card extravagantly and buy things you can’t pay for the same month you charge them (unless you’re sticking it to the credit card issuer by making full use of a 0%-interest period), then you shouldn’t attempt credit-card churning.

Organization and Execution.  Getting the bonus only makes sense if you can avoid the fees, which requires research to know what could go wrong.  You have to read the fine print.  It’s a good idea to record the pertinent facts (like when the zero-interest period ends, when the annual fee comes due, etc., for each each card you have) in a notebook or spreadsheet.  You not only need to know the details and have them at hand for reference, you also need to remember to act so as to minimize your costs: this means you have to pay off the entire card balance as soon as it’s due or before the 0% interest period ends, definitely before any late fee accrues.  It means you have to remember to cancel the card before you’re charged an annual fee.  If you can’t manage this, forget about credit-card churning.  (Related: Banks are more than happy to issue a credit card to you, allow you to make charges, and then say you’re not getting the sign-up bonus because you already had the same card and canceled it some time earlier.  Keeping good records and reading the fine print or making a phone call to ask a question can spare you from this disappointment.)

Basically, you and the credit-card issuer are making a bet.  You’re betting you will be able to resist temptation and play (and pay) by the rules.  They’re betting you can’t.  If you fail, you might get the $150, but end up owing the bank many times that amount in interest and fees — which is exactly what the bank wants.

Your Credit Score.  Opening a lot of credit-card accounts and making charges will almost certainly cause your credit score to decrease, maybe by 30 or 40 points or who knows how much?  This is something you should not be doing if you are going to be applying for a loan to buy a house or a car any time in the next several months.  You might also want to abstain from credit-card churning if you’re applying for a job as some employers look at credit scores.

What Counts Towards the Getting the Bonus.  Banks are wise to credit card churning and certain charges may not count towards getting the bonus.  Cash advances and balance transfers don’t count.  Buying gift cards doesn’t count (although I wonder if the bank would know if an eBay purchase was a gift card?).  Some cards won’t allow you to use Plastiq to for a mortgage payment.  I’ve considered the idea of meeting the bonus-level spending requirement by buying something on eBay that’s valuable and easy-to-resell (maybe a collectible gold coin?), but I haven’t done this yet.  The transaction and shipping costs, along with the risk that the resell price might be a little lower than the price I paid, might be worth it — if the bonus was large enough.

Problems .  Things can go wrong in unexpected ways.  I logged onto the the website for my water and sewer service and paid the currently-due bill on one of my new credit cards.  A week later, they deducted the amount due from my checking account, as they normally do.  I had to call them to get a refund.  You would think their system wouldn’t take a payment when none is owed, but, oh well.  I guess I should have discontinued the automatic bank drafts payments before I paid with a credit card.  I’m afraid something similar could happen if I pay my property taxes with a credit card while they’re still being paid from an escrow fund by the bank that holds my mortgage: I would pay with a credit card and then the bank would pay too, and then I’d have a dickens of a time getting the extra payment back.

Credit card churning: for some it might be easy money … for others it might be playing with fire.  Proceed with caution.  If you want churn, make sure you first learn, then make sure it’s the bank that gets get burned!

$300 Bonus for Opening Checking Account

bank_of_americaBank of America, where I currently pay my mortgage, offered me a $300 bonus if I opened a checking account and deposited a certain amount into that account within three months.  The required amount was about 3 times what I pay in my monthly mortgage payment, so to start earning that $300, all I had to do was open the account (which took about 10 minutes) and set up a direct deposit allocation on the intranet at work (5 minutes). That’s it.

Now, instead of logging onto the Bank of America website each month and paying the mortgage from my credit union checking account, I use the same BoA website and pay the mortgage from the new Bank of America checking account.  I’ve set up the direct deposit so that each time I am paid, which is every two weeks, half of the money I need for the mortgage payment is sent by direct deposit to the BoA checking account.  Over the course of a year, this will be enough for 13 payments instead of the required 12, so I’ll probably use the extra amount for additional payments towards the mortgage principal.  I can make the mortgage payment every 4 weeks (every other payday) and I’ll be making 13 payments in 12 months.  I’ll put the $300 bonus towards the mortgage too.

Eventually, when it can be done without incurring any “account closing” fee, I’ll probably close the account (which should take another 5 minutes) … and wait for next time a bank is willing to pay me a bonus for opening a checking account.

$300 for roughly 30 minutes of work is around $600 per hour.  Nice work if you can get it.*

This isn’t the first time and I hope it won’t be the last.  Given the amount of interest I paid due to unwise use of credit cards when I was young and stupid, it’s nice to be getting some of it back.


Accounting For Different Kinds of Accounts


Different kinds of accounts where you can keep your money … and how to use them.  This is the way I do it.

Checking account (for day-to-day expenses).  Even if it’s only used to fund ATM withdraws, debit-card purchases, and online bill paying, everyone should have a “checking account” — despite the fact that many people don’t even have blank checks these days, Indeed, the last time I purchased blank checks I probably got enough to last the rest of my life.  A checking account is for your usual day-to-day bills.  It should have enough money to cover transfers to your savings account (pay yourself first) as well as your regular monthly expenses, such as the rent or mortgage payment, and bills for utilities, groceries, transportation, and other things that you pay for daily, weekly, or monthly.  Whatever comes out of your checking account should be replenished by income coming in.  (Did you see the post about how the money in your checking account is like a tank of water?)

In addition to your checking account for expenses that come due every month or more frequently, you should also have separate accounts for expenses that come less often.

The first three, like the checking account, should be at a credit union or bank.

  • Emergency savings (unexpected expenses).  Everyone should have money set aside for emergencies, those unfortunate unforeseeable expenses: accidents, medical problems, periods of unemployment.
  • Short-term savings (once-or-twice-per-year expenses).  Money set aside for foreseeable and predictable expenses that come once or twice per year, such as property tax and homeowner’s insurance payments, and expenses for birthdays, holidays, and vacations.  At my credit union I have a “Holiday Club” account that automatically takes $83 (or any amount I choose) from my checking account each month and deposits it into the Holiday Club account.  Then at the at the end of November, the accumulated sum is automatically moved back into my checking account.  It’s a pleasant surprise to get $1,000 just in time for Christmas.
  • Medium-term savings (once every few years or just a few times per lifetime).  Money for foreseeable, but perhaps not predictable, expenses that come less often than yearly, such as purchases and/or repairs of automobiles, refrigerators, heating and air conditioning systems, washers and dryers, and major household expenses such as a new roof.  Other medium-term savings goals might include medical or dental procedures; weddings and funerals; house purchases, remodeling or additions; college educations, starting a business, or moving to a new house.  It’s also good to have ready cash for unexpected opportunities such as great deals at a going-out-of-business sale or a used car at an especially good price.

The last one should be with a mutual fund company so the money can be invested in stocks.

  • Long-term savings (once in a life).  For foreseeable expenses that come just once in your life, such as buying your dream house and retirement.  Basically, your 401-K, IRA, and similar.

How much should you put into these savings accounts each month?

There’s no definitive answer.

Let’s start* with at least 10% to 15% of your total household income going into your retirement savings.  After that, maybe an additional 1% to 5% of your income distributed among the short-term, medium-term and emergency savings accounts?  There are many factors to consider:  How large is your family?  Are your kids going to need braces?  Can they get scholarships for college?  How handy are you when it comes to doing home repairs?  Do you need to buy new cars or can you be content with “pre-owned” cars?  How much will your home addition or dream house cost?

Your goals should be something in the order of at least $1,000 dollars each in emergency savings and short-term savings and perhaps several thousand dollars (or perhaps much more) in your medium-term savings account.

You might want to think of it in terms of your income:

    • Emergency savings.  Equal to at least 3% of your annual income or $1,000 to $2,000 (whichever is higher).
    • Short-term savings.  At least 3% of your annual income or $1,000 to $2,000 (whichever is higher).
    • Medium-term savings.  At least 10% to 50% of your annual income.
    • Long-term savings.  25 times your annual income (when you reach retirement age).  In other words, millions.

There are many experts who say your emergency saving account should have 3 to 6 months of living expenses (all the normal food, shelter, and transportation expenses). This might be around 30% to 40% of your annual income.  One of the reasons for this amount is to maintain your household during periods of unemployment.  If you think of unemployment of an “emergency” then your emergency account should be correspondingly larger.  Alternatively, you could view your medium-term savings as your unemployment reserve.  How likely you are to experience a period of unemployment is also a consideration.

* This assumes you have no debt other than a mortgage.

Homeowners: Pay Property Taxes and Insurance Yourself

Generally, home mortgage payments consist of 4 parts:

  • principal (a partial payment toward the amount that was initially borrowed)
  • interest (the cost of “renting” the remaining loan balance)
  • property taxes
  • insurance

(These are often called “PITI” for “Principal, Interest, Taxes, and Insurance”.)

mortgageWhen someone borrows money to buy a house, the lender has a good reason to want to make sure that the property is insured and the taxes are paid.  (If the house were destroyed in a fire or other calamity and the borrower just walked away, the lender would have no way to get their money out of the property.  If the taxes aren’t paid, the local government could seize the house and sell it to pay the taxes.)  Because lenders prefer to make sure that insurance and tax bills are paid, and paid on time, they include those costs in the monthly payments and pass the money along to the insurance company and local government.  The money is kept in a separate “escrow” account until the next insurance bill or tax payment is due.  Federal Housing Administration (FHA) loans always come with an escrow account and include insurance and taxes in the payments.

Many homeowners like escrow accounts just fine.  It’s convenient.  Not making insurance and tax payments means two fewer things to worry about.  Someone lacking in financial discipline might not be able to put enough money aside for the tax and insurance payments, and that could lead to trouble.  Forgetting to make the payments can lead to late fees, or worse.

However, someone who is able to manage their money and wants to spend a little extra time doing so might want to consider a no-escrow loan.  While this does not reduce your taxes and insurance costs, it does let you keep your money in your own account until you need to make the payments.  This might earn you some interest from your credit union or bank where you keep your checking and savings accounts.  Additionally, you might more easily meet some minimum balance requirement that eliminates monthly service charges.  If you’re making the homeowner’s insurance and property tax payments, those are two more things you can use in your credit-card-churning scheme, if that’s your thing.  Remember: taxes and insurance are usually thousands of dollars per year.  To make sure you have the money when the bills are due (which may just a few times per year) you need to set aside hundreds of dollars each month.  If possible, it’s a good idea to automate things and have money automatically move from your checking to a dedicated savings account — but you still need to keep an eye on things and be sure you’re ready to pay the bill when it comes due.

It’s may be easier to avoid escrow on a new loan and harder or impossible to remove an escrow requirement from an existing loan.  In general, in order to remove the escrow account from a mortgage, the mortgage has to be current with no late payments for a year or more, the balance remaining on the loan can’t be too high compared to the appraised value of the house, and the borrower has to have a good credit rating.  Even if you can avoid escrow, watch out: banks might charge a higher interest rate on a no-escrow loan.  As always, shop around, read the fine print, and negotiate.  Finally, in some states, mortgage lenders might be legally required to pay interest on the amount in the escrow account.  If that’s the case for you, then it probably makes no sense to have a no-escrow loan.

Spending is Like a Faucet

An old song says “Love is like a faucet … it turns off and on”.*  I’m not so sure about love being like a faucet, but I do know that spending is like a faucet.  It can be turned off and on.  Or it can be set to any level between the off and on extremes.

We can extend the imagery a bit.  Let’s say the spending faucet is attached to a water tank.

  • Income is like water flowing thru a pipe into the tank.
  • Spending (in other words, buying things that are sure to decrease in value, such as automobiles, clothes, food, furniture, etc.) is like water flowing out of the tank through the spending faucet.
  • Wealth, the accumulation of money, is like the amount of water in the tank.

Spending = Income


Is your situation like the first image?  Money is flowing into the tank (as income), but it’s flowing out (as spending on things that quickly decrease in value) just as quickly. The tank will never be filled.  There will never be any accumulation of wealth.  This will be true as long as Spending = Income.

Note that as long as Spending = Income is true, the tank will never be filled — no matter the amount of income.  This first image could represent a person with an income of $20,000 per year and spending of $20,000 per year.  Or it could just as well represent someone with an income of $20,000 per day and spending of $20,000 per day.  No matter how high the income, people who spend all they earn — people who are unable to live below their means — will never have wealth.

Sadly, this is how many people live their whole lives.  They wonder, like Senator Hoar, why they can never get ahead.  In some cases, I believe, people are doomed to financial failure because they can’t even imagine that there is any other way to handle money.  Perhaps because they’ve never been taught.  Perhaps they had no mentor, no example.

Consider the case of many former professional athletes.  There are hundreds of former professional athletes who each earned many times what I will earn over the course of my entire life.  Yet just a few years after their playing careers were over, they had no money.  Incredible as it seems, my net worth (a relatively small amount of money) is more than theirs and there’s a good chance that the net worth of these former millionaires will never again exceed mine.**

Spending < Income


The second picture is clearly different.  The tank is filled, representing an accumulation of wealth.  Look at the picture for a moment and you’ll see why the tank is filled, and will stay filled:  The spending faucet has been adjusted so that spending has been reduced.  Spending is now less than income (Spending < Income).

Also notice that the tank has another pipe.  The new pipe leads to saving and investing.  We can think of the tank as a checking and emergency savings account at a credit union or bank.  The saving and investing pipe leads to retirement savings accounts, stocks, bonds, IRAs, 401-Ks, and other investments.  (It’s a good idea to have different accounts for money that is intended for different purposes.)  Buying shares of stocks or mutual funds might be thought of as “spending” but there’s an important difference: it’s buying things that have a good chance of increasing in value and paying dividends or interest.

If your personal financial situation is like the second picture, then you have learned the lesson of living below your means and allocating part of your earnings for savings and investment.  If your situation isn’t like the second picture, then there’s an important lesson you need to learn.  Start today.


Here’s another image, which is the best way to think about your financial plumbing.  It’s basically the same as the second picture.  You can see that Spending < Income because the tank is full.  But, by using the pipe at the bottom to represent saving and investment, and the pipe at the top to represent spending, the third picture represents the application of another important principle, which is, “Do not save what is left after spending, but spend what is left after saving” (Warren Buffet).


** There are also people who are even worse off than those who spend all they earn.  There are people who are in the category of Spending > Income.  Through borrowing, they actually spend more than their income, finding themselves with debt and compounding interest on the debt.  I can’t find a way to illustrate this with a picture of water going into a tank.  Spending > Income may be possible for a short time but is completely unsustainable over the long term.  The sooner they stop spending more than they earn, the better off they will be.