Archive for September, 2008

…And save yourself mental clutter

Most people I know hold a single bank account or at the most 2 accounts – out of which 1 is a salary account. This account is used for all financial transactions in life -

• Regular expenses like groceries, electricity, phone etc
• Irregular expenses that do not occur every month but at specified times in a year like insurance, car service etc
• Miscellaneous expenses for items such as eating out, movie tickets (or indirectly to credit cards)

Image source: Vangelis Thomaidis

Why having a single bank account is bad for you?

A single inflow and outflow box for your financial transactions does not make sense. Here’s why.

Difficult to set a budget and track against it

If you make a rough budget, you apportion it to major categories such as groceries, electricity etc. However, your transactions don’t happen in a nice, single purchase. Most often, they are distributed over the month, making it difficult to track against the budget, especially if you do not track at a granular level.

Also, if you are like me, you withdraw cash at ATMs for payment towards many of the expenses. This appears in your bank statement as withdrawals, making it difficult to allocate it to the appropriate category.

For some tips on tracking your expenses, see my post on 5 easy steps to find out where your money is going

Limit impulse purchases

I have not yet reached the stage of setting limits for entertainment/eating out/impulse purchases (music, food, movies), since I can’t seem to reliably predict those expenses. You may have budgeted for it. In both these cases, it is easy to go overboard and spend more (since you have the money now).

Security issues

With almost every service provider offering the option to pay bills online, it is fast becoming the method of choice for bill payment as well as purchases. However, using the same account for online transactions may increase your exposure to security issues. With ATM/Debit cards, there is limited liability even when you complain, as the money removed from your account cannot be recovered.

Funds not available for irregular expenses

When the bills for car insurance renewal, annual premium payments or other expenses that do not occur monthly come up, you may find yourself with a shortfall in funds. You then have to dip into debt sources to fund these payments.

Low interest rates

Your savings account, even if you have a lot of spare cash in it, will earn you a measly 3.5% interest rate. Income Tax returns, sale proceeds and other spare cash tends to lie in such accounts waiting to be spent (and does vanish into GOK accounts!)

Solution: Create separate accounts

Regular Bills

Setup specific accounts for regular and irregular payments. With most banks allowing online payment, regular bills and operating expenses such as fuel, vegetables etc can be bought using the regular account. This regular account can be the pay-linked account provided by your company.

Irregular Bills

Total all irregular income for the year (planned) and divide by 12, to get the amount for each month. Set up separate account for the irregular expenses and pay from that account.

Target accounts

If you have other financial goals and you have budgeted for it, either keep a separate account or use the irregular expense account.

For investments such as payments to mutual funds, use a separate account for inflow and outflows. This also makes it easier to find out your tax liability for short-tem capital gains and pay accordingly. [It also makes it easier to get a TDS certificate for such gains]

Note: In India, ICICI Bank, for example, allows you to link your accounts, so that you can transfer money between your investment account and savings account easily.

The Smart Account

For irregular and any target accounts, choose a smart money account  where after a defined threshold is reached, any extra money is put into a separate high-yield account (with Fixed-Deposit rates). This account has full liquidity and you can take everything out if you need.

Note: In India – ICICI, HSBC, Citibank, HDFC Bank are among the many banks that offer this type of account.

Diversify

Ok, this is a word of caution I added after the recent chaos in the banking industry. Like any portfolio, it would be wise to spread your accounts across banks.

Choose your Account type carefully

All banks generally offer different types of accounts with different facilities, minimum account balance (MAB) and charges. Choose very carefully among these accounts to avoid unnecessary charges since you may not need to use all the features of a full-fledged account. For example, many banks offer a no-frills account with zero MAB, a basic ATM card and access to online banking for little or no annual charges. Choosing different banks allows you to avoid putting all eggs in one basket

Having separate accounts allows you to plan efficiently and avoid the mental clutter when dealing with different expenses that arise at different times.

Share with us your strategies for keeping track of different expense categories, specifically variable and irregular expenses. While you are it, please take a moment to participate in the poll below.

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You know that feeling – no money left in the bank, but you are not really sure where it has all gone. Oh, you might be doing a bit of budgeting and have paid off all your regular expenses. What about the rest?

Once I got started on this, I expanded the question: Where do I spend my money? Is there some "GOK" account into which my money is leaking?

Step 1: Download your account statement for the last 1 year

To understand where I am spending my money, I downloaded my bank statement for the last 18 months in MS Excel format. Citibank, where I have my account, does not give an easy-to-use download format, at least in India. If your bank offers a way to download in some other format, such as MS Money, you may find it easier to do this analysis in MS Money itself.

Step 2: Remove inflow transactions

Once I had the Excel set up the way I wanted, I removed the "Credited" column, as my goal was to analyze my expenses. I have a stable job and the inflows are pretty constant. I also removed some superfluous transactions such as cancellations, fuel surcharge reversals etc.

Step 3: Categorize your transactions

I then categorized each transaction based on a pre-defined set of tags. For example, purchases at a music store would go towards Music while purchases at a supermarket would go towards Groceries. Of course, there might have been instances where I bought some music at a supermarket, but I had no way to get that data.

I tend to use cash a lot (primarily because plastic is not so common in India as in the US and Europe), so there were a lot of ATM withdrawals.

This was an eye-opener for me, as I realized could have done anything with those withdrawals. I might have bought groceries, fuel, music or any other expenses. I did not have that level of granular data! As I wanted to get to the end by now (!), I simply clubbed all of them under household expenses.

Step 4: Analyze results

Once the transactions were categorized, I used some formulae to sum the transactions under their respective categories. A pie chart seemed the best way to show the transactions by volume, so I made a pie chart of my top expense categories.

The first category was the "household expenses" as expected. The second largest category was a one-time mortgage payment. Events, Food and Travel expenses were the next set of expenses.

Step 5: Create Goals and Make a Plan

This is all very well, but what is the use?, you may ask. Based on the data, I am not able to really see the opportunities for cutting the flab. I decided there were a few things I needed to do:

1. Keep a more granular track of ATM withdrawals. I decided to log each day’s transactions in an Excel and treat the money with me as a sort of cashbox. While I need to be vigilant, I decided to adopt a balanced approach and track major expenses. Minor ones would be a sort of miscellaneous category.
2. Increase use of electronic transactions in places where a Debit card is accepted. My bank does not charge me on any debit card transactions, so I should start keeping less cash.This would create a more granular transaction list.
3. Keep a separate track of discretionary expenditure. I will keep the bills when we eat or go out for movies etc.
4. A stretch goal would be to identify impulse purchases when we go shopping to the supermarket. While we do make a shopping list, we tend to pick some other times which we think might be good to enjoy. I am not probably going to cut those impulse purchases out, but at least know how much I spend on them.

I will redo this exercise 3 months later to see if I can identify areas of improvement. I have also promised myself that any savings I see would go into the Emergency account, which is dangerously lean these days.

Do you track your money using Excel or other methods? Share your comments, tips and tricks with us.