May 1st, 2021 paycheck

I thought things would have settled down — I was wrong.

The US Federal Government extended the tax filing deadline, which extended how long I could contribute to my Roth IRA for 2020. So, the cash reserves I have will be going to try and maximize that contribution.

I had a coaching session with a Wave Advisor to improve and verify my bookkeeping skills. Come to find out I’m doing pretty okay on that score and they were able to help me with a few interactions and capabilities of the app.

I was introduced to a book and labels I didn’t know existed.

For the last 15 years I’ve been using a time-based approach that mimics the envelope method. I had my trusty spreadsheet. Income would come in. I’d account for paying myself first. Next I pay bills that can’t be paid with credit cards; rent, for example. Then the focus was on the revolving loans (credit cards and lines of credit), followed by any terminal loans (student loans and car loans). Then there was a section for preparing for future, known expenses. A cash allowance I gave myself came next. Then there was long-term investing and savings.

I loved this spreadsheet.

It helped me lay out a plan before committing to it. Then, once I had the plan in place (after about 10 minutes), I’d transfer the money and make all the payments. Then I wouldn’t have to look again until the next time I ran the spreadsheet (on the first and fifteenth of each month). Now, I’m pretty sure I can get rid of, or at least dramatically change the spreadsheet’s position in my financial execution.

The first mind-altering concept I was introduced to was that of Fund Accounting. In short, Fund Accounting is used by not-for-profit organizations and is the corporate version of the envelope method used at the personal level. You create funds, each fund and the money within it have stipulations and constraints for what that money can be used for. The US Federal Government, as a not-for-profit organization, works this way. Social Security is a fund. Money is put in and stipulated to be used to pay those receiving the benefit. Of course, using it for the purposes intended is up to the trustee of the fund. In the case of personal accounting, that’s you.

This eventually led to the book Profit First. This method uses sub-accounts at your financial institution to create funds. The the funds recommended by the book are:

1. Income,
2. Profit,
3. Taxes, and
4. Operating Expenses.

The author, Mike, does say you should have a mirror for the Profit and Taxes accounts at another institution as these are reserve accounts and it should help dissuade you from withdrawing money on a whim. The idea is that all money received from third-party people starts in the Income account. Then you have percentages set to redistribute the money from that account to the others. Mike talks about how this methodology aligns with Generally Accepted Accounting Principles and for-profit business bookkeeping, and how this can be used at the personal level.

Here’s the implementation I decided to shift to.

1. Income account: I opened another checking account and updated my payroll department to have my paychecks go here; I have a bit go to my secondary institution as well (more on that later).
2. Hold (this is the Profit account from the book): I renamed the savings account I have with my primary institution.
3. Taxes: I opened a secondary savings account.
4. Operating Expenses: I renamed my original checking account at my primary institution.
5. Runway: I renamed my money market account at my primary institution.
6. Investment Pass-Through: I opened another checking account.

This is important: Each of these are sub-accounts. So, when I sign in to my primary institution, I see all six of these sub-accounts. They are not unique accounts at the institution. (It’s similar to a brokerage account at, say, Vanguard; each “fund” is contained inside the “account.”)

For this run, I closed all my time-based accounts (those savings accounts meant to be used around the first of each month) and moved their balances to the Income account. Then, leaving around one thousand USD in the Income account, I transferred the money to other accounts:

1. 10 percent to Hold.
2. 2 percent to Taxes.
3. Enough to pay credit card balances and bills that were due to the Operating Expenses account.
4. Nothing to the Runway account.
5. The rest went to the Investment Pass-Through account.

Let’s talk about the accounts.

The Investment Pass-Through account is the account connected with the companies I use for investments; think Fidelity, Vanguard, M1 Finance, and the like. This way it doesn’t get mixed up with my Operating Expenses fund, which has a different purpose. It also helps separate income received from third-parties from dividends and income generated by investments.

The Income account is where all payments from third-parties come into my world. If they use a similar system, their money would flow from their Operating Expenses account and into my Income account.

The Operating Expenses account is used to pay third-parties. It’s not a transfer from one asset account to another, it’s a transfer out of my pocket and becomes the income for someone else.

The Runway account is an extension of the Operating Expenses account. It’s an interest-bearing account; money making money.

The Hold account is the “pay yourself first” account and is interest-beating.

The Taxes account is the “pay the government” account and is interest-bearing.

A couple of notes before talking about how money flows and why.

First, discussing the difference between time- and flow-oriented approaches in-depth is beyond the scope of these entries.

Second, because I’m more hands-on with this approach seeing where and how operating expenses can be reduced should be easier and I should be able to do it without having to rely on the tracking spreadsheet.

Third, I added a summary for how each account operates to the description of the account in the Wave chart of accounts. This further reduces the need for the spreadsheet while increasing the possibility of bringing in a third-party to manage this for me or at least see into it; thinking accountant or bookkeeper.

Finally, instead of using a separate sheet (tab) in Apple Numbers for each paycheck, I’ve consolidated everything into two sheets. One stores the past distributions and the other holds the current and future distributions on a rolling 12 month cycle, with two runs each (24 columns in total).

All right, let’s say this check was for 1,000 USD. It got deposited to the Income account, that’s the event.

I took 10 percent (100 USD) and put that in the Hold account. I took 2 percent (20 USD) and put that in the Taxes account. I paid my bills due and paid off my credit cards and transferred that amount to the Operating Expense account. I transferred the rest to the Investment Pass-Through account and told my brokerage firms to take out the various amounts ear-marked for them.

I didn’t apply all the percentages this time because I’m trying to draw down my cash reserves and feel I have the risk tolerance and capacity to do so pretty quickly.

When it comes to passive income, dividends are king of the hill. Put money somewhere and more money gets generated; as long as you don’t spend the money that’s in there.

For some accounts (401(k), IRAs, and the like) dividends don’t count as taxable income. For other accounts, they do. In the US, if you earned more than 10 USD in taxable interest income from an institution, you’ll receive a 1099 form letting you know. And, the government may take a cut from that money.

That’s why the Tax account is important.

My primary income comes from W2 employment, which means they already take out various money for taxes and pay them on my behalf. Awfully kind of them and I do what I can to make sure I don’t owe money or receive money when I file taxes. If it swings more than 300 USD in either direction, something has gone awry.

That’s why I put the 2 percent into the Taxes account every time I run through this paycheck protocol. That’s also why I’ll either put in an amount equal to my taxable interest income earned since the last time I ran through this or I will literally transfer the dividends from one account to the Taxes account.

After a while, the Hold account should start accumulating a pretty healthy balance. On the first day of each fiscal quarter (January first, April first, and so on), I plan to take 50 percent of the available balance and either redistribute it — most likely to the Runway account, the Investing Pass-through account, or a little bit to both.

We’ll find out what I decide at least initially when the June first distribution happens.

The Taxes account needs to have a balance to handle taxes for the year. If I owe taxes when I file, I’ll transfer the amount I owe from the Taxes account to the Operating Expenses account and pay the taxes. Then, because I want those dollars working as hard as they can for me, I will make a transfer from the Taxes account to the Hold account.

I’m thinking I’ll do something like this:

1. Transfer taxes owed to the Operating Expenses account.
2. Subtract any deposits made since January of that year from the Tax account balance.
3. Then transfer 80 percent of that figure to the Hold account.

This way the money doesn’t disappear immediately from my cash accounts and is fed back into the pipeline to be promoted or at least put to better use by way of the quarterly redistributions.

Something comes out of the Operating Expense account unexpectedly.

There are a lot of options here and I’m going to describe them in general and which ones I have.

Institution default: In some cases institutions will not pay the item that came in that would have drawn the account negative. There’s usually a fee from the institution if that happens. This is the deep fallback option.

Line of credit: I have a personal line of credit with my primary institution. This is a revolving loan that will be advanced automatically if something comes in that would have drawn my account negative. Some institutions let you use a credit card for this, I avoid that option. The reason I avoid it is because overdrafts are considered a cash advance. Cash advances are often charged daily interest instead of monthly (similar to the line of credit); however, when you make payments, the payment will sometimes go to pay down purchases before going to pay off cash advances (not the same as the line of credit as there’s only one type of charge there).

Another account: Another option, which I’m setting up is to have the funds drawn from another account automatically; specifically the Runway account. To be clear, there will be a chain here; like an overdraft conga line. If the Operating Expense account is about to go negative, money should get transferred from the line of credit. If the line of credit is maxed out, funds should be drawn from the Runway account. If funds aren’t available in the Runway account, funds should come from the Hold account. The idea is to set up the distribution and redistribution ratios in a way that this never happens.

At no point should funds be taken from the Taxes account.

• April 15th, 2021 paycheck
• May 15th, 2021 paycheck