How many financial accounts do you have? Five? Ten? Twenty?
You probably have more accounts than you think you do. When I look at all of the financial accounts that I have, it makes my head spin. If all you have are the bare essentials: 401k, Roth IRA, a checking account, a savings account, an online savings account – then you’re already talking five accounts just to start and that doesn’t even include credit cards! Make any major life decisions and you start adding to your total. Leave a job? Add a Rollover IRA. Move? Add a local bank account. It doesn’t seem to end. I personally have a checking and savings account with a credit union in New York, I haven’t lived there since I graduated high school ten years ago!
While it may seem like too many accounts, each one plays a pivotal role in building your financial fortress and it’s important to have a good idea of what role each plays. I invite you to join me on our tour of a typical financial fortress.
Your Moat – Checking & Savings
Your moat is first line of defense against expenses. Your moat is your checking and savings accounts at your local bank. You pay your credit cards, your rent or your mortgage, your electric bill, and your grocery bill from this account. When you go out for a night on the town, this is the account you use. This is also the account that gets replenished with your direct deposits or your paycheck deposits (you should consider direct depositing paychecks if you aren’t already). This account probably doesn’t give you much interest, maybe 1% max, but that’s acceptable because money in this account isn’t likely to stay in there for more than a month. When disaster strikes, hopefully it doesn’t run through the money in this account… or it’s onto the outer wall.
The Outer Wall – Emergency Fund
If the regular checking and savings are your moat, constantly emptying and filling with the best sludge and moat monsters you can find, then your emergency fund is that outer wall. Some people recommend three months of expenses, some recommend six, some go as far as a year of expenses. While those are good rules of thumb (they reach those amounts because they see job loss as the most prevalent emergency, so they put the fund’s amounts in those terms), I think that you should tweak it to whatever you may be concerned about. If you’re driving a beater of a car and know that it’ll be replaced soon, maybe you increase your emergency fund allotment. I would avoid going less than three months of expenses though because this is for emergencies after all and you won’t see these suckers coming.
Your emergency fund will probably be in something semi-short term, not 0 day liquid (I don’t know if that’s a real term but I mean that you can get at the cash immediately), and so something like high rate cd or an online savings account would be ideal for your emergency fund. Online savings accounts aren’t 0 day liquid, it takes a few days to get the money out (usually a week), but it’s a guaranteed rate of return and they’re better than certificates of deposit and bonds (which have early withdrawal penalties).
The Inner Wall – Investment & Retirement Assets
If the raiders have breached the outer wall, they’re now up against your inner wall – your investment and retirement accounts. Whether it’s a 401K, your Roth IRA, or just the stocks and funds you stick your extra money in, these will be your accounts that you tap into in the event of disaster after your emergency fund. After the daily accounts and the emergency fund, I like to invest the remainder in some mutual funds so that they can grow a little faster than 3% (going market interest rate for online savings accounts) and I believe this is the correct strategy. The 401K and the Roth IRA are obviously less liquid than a standard brokerage account since you’ll pay penalties on some of that for early withdrawal, but unfortunately you may not have a choice if a significant disaster strikes. Luckily, for certain emergencies, namely medical, some of those penalties are reduced.
The Guards – Credit Cards
As I was drawing this analogy, I knew that plenty of people, in the event of a disaster, turn to credit cards a short term solution. I wanted to put credit cards as the very last possible defense because it has the potential to turn a small problem into a massive one. However, if you have the funds, you can always use a credit card to earn rewards and then pay it off with your funds. If you need a $200 car repair and have the cash, you can float yourself some money with a credit card instead of tapping your emergency fund reserves. In that respect, you can think of the guards as the soldiers you put at the front lines as well as the final line of defense. I’m not advocating credit cards as a last line of defense but if all else fails, they are an option.
The High Tower – Your Assets
Lastly, to finish out the castle analogy, we have the high tower: your car, your house, your spouse (just kidding), your jewelry, your flat screen television; if things have turned so far south, sometimes you have to sell some of your assets to make it to next month. Of course, like all analogies, this isn’t an absolute rule – should you raid your retirement fund or sell your flat screen television? I would argue that you should pawn the television and cancel the cable before you raided a 401K, but what about a car?
While nothing in life is as simple as an analogy and it may be a stretch to try to fit every last aspect of your finances into a castle analogy, I thought it would be fun to take a look at it from this perspective. What do you think?please add your thoughts now! }