The money machine
How would you like to have a machine that spat out money every month? Of course you would, who wouldn't? Let me show you how to do it, and how anybody can create their own money machine.
To understand the machine, simply follow the arrows. Each box is for a different general purpose, and is made up of one or more accounts suited to the specific purpose. Ideally you add and remove money in the machine soley through your main checking account, but in practice you can do so with any of the accounts. It is probably best to build the machine one box at a time rather than trying to do it all at once.
Short term, fluid, redeemable: In the first box is the money required for immediate needs. The money needs to be fluidly available and accessible, because you will need this money any time of day, any day of the week.
The immediate-needs money should be kept in multiple accounts, because there are multiple types of immediate needs. These include the following
- Daily spending money
- Monthly household expenses
- Emergency fund
- Separate funds for each item which you're saving for over the long term (e.g. "new car fund", "travel fund", etc)
In my case my bank, Netbank, lets me establish as many accounts as I like within the grouping assigned to "me". I have several "money market" accounts serving each of the purposes above, in addition to the checking account through which all bills are paid.
In these accounts I show the interest payments feeding directly back into the account, because this is the way those accounts naturally work.
Medium term, income producing, stable value: The next level of investment falls into one of the three stated attributes. A "medium term" investment is one you wish to redeem in 5-10 years. An "income producing" investment is one geared towards giving income, and these investments rarely also include any growth in the value of the investment. In fact, generally the "income" investments are thought to be best for retirees where the goal is to have ones living expenses paid by the income deriving from the investment. With a "stable value" the investor is unlikely to lose any of the original investment.
In this box I show the investment income flowing back to the "money market" account. That is partly because it is most convenient with most brokerages to do this. Also I am leery, in non-tax-sheltered accounts, to have automatic reinvestment happening. There is a common piece of advice to have automatic reinvestment of dividends, but if you do the tax accounting of this for the purpose of determining your cost basis will be a nightmare because each purchase must be accounted for individually. Instead, in my accounts I have the investment income pile up in the money market account until it is a high enough level to warrant another investment.
Long term, growth oriented, risky: The last level of investment is where you put money you can afford to lose completely. This isn't money you're trying to live on, or expecting to have in 5 years, but instead it's money you are trying to grow through investments, and the time horizon is very long.
Building the machine
I don't recommend building your money machine all at once. Several steps are needed early on.
You need to understand the construction of your machine, and not to parrot mine. For that matter, I don't even do the same as the picture above. That picture is an "ideal" form of the money machine. The machine you end up with will be built over time anyway, and it will evolve over that time as you learn the methods.
I cannot stress this enough, understand the concepts in your own way. By building the machine from principles you value, you make it your own machine. As your creation you have more explicit control and ability to make decisions that make sense for you.
Begin with the first box, getting it in order. What you do afterward is up to you. The first box is the foundation, and the stronger a foundation you build the more secure you are overall. For example, if you optimized your money machine for long term investment, and then lost your job, the lack of emergency funds might come at an inconvenient time where the long term investment plans haven't come through as yet. The resulting scramble could be far more expensive than you could dream. However, if you have a sufficiently sized emergency fund (6 months living expenses is the common rule of thumb), your "scrambling" might be limited.
Finally, take stock of where you are. If you're ready to retire, maybe the last thing you want to do is speculative investing. In the end the decisions are all yours to make. The more awareness of your current situation you have, the easier it is to make good decisions.
Planning for buying a car: You can expect 3-5 more years of useful life from your car, and you don't want to sell it right away. There's no need to buy a new car right away, but you know that in several years time your current car will wear out and need to be replaced. You easily can set up a separate banking or brokerage account meant to hold the funds you are saving to buy the new car.
How much to contribute to the car? Let me suggest, as this is what I'm doing, to contribute the same amount you would spend on a car payment. The Motley Fool web site has a set of finance calculators, one of which lets you compute a likely car payment. Simply put in an estimated car purchase amount as the loan amount.
Of course when it comes time to pay for the car, you will have saved the money already and can pay cash. Right? Maybe not. A consideration is if you do wish to pay cash, the number of months and the monthly contribution determines how much you will have saved by the time it comes to pay for the car. Will you have saved enough? Maybe the contribution should be larger? Or maybe it's too much. What do you do with your monthly contribution when you've reached your savings goal?