If you've read up on money saving systems, you've probably heard of the envelope system. Its a simple method with the following steps:
Create an envelope for each type of monthly expense and identify an amount of money needed for the month.
Add the designated amount of cash into a labeled envelope to be used only for the intended purpose.
The first (and most obvious) problem with the envelope system is that nobody uses cash anymore. The second problem is there are too many buckets.
The Savings Waterfall System is a digital envelope system that uses bank accounts instead of physical envelopes. To use this system, you need three accounts:
- Main checking account – this is where your direct deposit goes.
- Second checking account.
- High-yield savings account.
Here's how it works:
On pay day, you leave the funds needed to pay any recurring bills in your main checking account. Transfer into your second checking account the funds you plan to spend that aren't recurring bills, for things like groceries, supplies, repairs and maintenance, and any discretionary spending.
The funds you have earmarked to NOT spend are deposited into a high yield savings account, and remain there until you decide how to invest them. You can also transfer the funds directly into an online brokerage account.
Follow Your Budget
If you use the savings waterfall system, you will find its much easier to follow your budget. The only debit card you should carry around is the one for your second checking account, where you transfer discretionary funds. When this account is empty, you are done spending until the next pay day.
So spend carefully.
How Much to Transfer
If you aren't sure what amount to transfer to each account, use your budget or last couple of months as a guide. List out each recurring bill you pay and the amount for each in a spreadsheet (Microsoft Excel or Google sheets).
See below for an example of a Funds Transfer Worksheet:
If you don't want to start from scratch, download this Excel worksheet and adapt it to your needs.
Now here's an important nugget of wisdom for you:
I recommend always leaving a balance in each account in case you miscalculated, or a bill amount changes that you didn't expect. You don't want to run into an issue where you can't pay something important because you're short $10.
Free Online Accounts
If you use an online bank like Ally Bank, you can open as many checking and savings accounts as you want for free. They also offer savings accounts with competitive interest rates, and a brokerage account as well!
Another bank with a competitive savings rate is Axos. This bank also offers free checking accounts, and has been around for 20 years. It was one of the first online banks.
The nice thing about having your accounts tied together is that you can easily transfer money back and forth without delay. This works great IF you have self-discipline and don't abuse the convenience by overspending out of your discretionary account. A one-stop shop for all of your accounts.
I use Ally Bank for my checking and savings, and TD Ameritrade (for IRA) and Tastyworks (for non-IRA) brokerage accounts. A little bit of separation between your wealth and your spending money is never a bad thing.
The Savings Waterfall System is a digital envelope system that coincides with your budget. It helps you bucket your money into three categories: recurring bills, non-recurring expenses, and savings. I hope this system helps you to maximize your savings and meet your goals.