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Understanding Your Financial Fortress
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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?
(Photo: akbar1947, Christiaan L, archidave, scuba04, BOND159, Beatnikside)
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Hey, good job Jim breaking this down….
This is an absolutely gorgeous and fun post: great images and very cool analogies. I wish I thought of it myself.
It’s nice to be king of such a mighty stronghold….
Too true. It’s a great way of explaining it … and such beautiful pictures too!
wonderful post….easy to understand and is applicable to people of all ages
great job!
How does one decide which one to build first? Or should you build all of them at the same time?
I am currently trying to save for a house and put money into a ROTH and if there is anything left at the end of the month build my reserve account. Should I follow this path or should I concentrate on building my ‘moat’ then ‘outer walls’ and finally ‘inner walls’?
Nice Job on the post.
Hey Dustin, I thought I would weigh in on your question. You left a number of details out of your post to use to make the decision between the Roth and the house downpayment. But as former Real Estate Investor and Broker I would keep your powder dry in an insured savings account in a small solid bank. No one has any idea what is really going to happen in today’s market. BUT one thing I am TOTALLY sure of is that when todays economic issues blow over there will be some incredible deals in homes and investment property. I would be looking to buy no soon than a year from now and very possibly as much as 3 or 4 years from now… don’t jump the gun. Ride the rental market down, as owners get less and less for their properties you can negotiate better and bette deals for yourself. When this situation begins to bottom out you will be sitting in the catbird seat with a nice chunk of downpayment money. You may be surprised how far it goes in the new market down the road.
regards,
Wayne
I would think that you build from the outside in… dig and fill your moat, then build up the outer walls, etc. The reason being is that when the bad guys show up, it’s that outer wall they hit first… you want that wall up, nice and strong (X month’s expenses) so you can handle those rough patches without having to sell your flat screen TV.
amazing post. i enjoyed it
This is the best post I’ve seen on a PF blog in quite some time.
Nice post Jim…I really enjoyed it. I actually have my emergency fund in a HSBC online savings account, and they issued me a debit card to use for the account. So I can access funds immediately, rather than wait a few days for a transfer. While I might have to pay some ATM fees, I think it’s a small price to pay to get out of a jam!
Nice analogy you gave. I also like the Disneyland high tower picture!
I love how you broke this down. I will forward this to my friends who are currently figuring out hw to build their financial fortress. Great Job!
You certainly broke down the spectrum, but for me credit cards are my moat because there is the propensity to slip and drown in them.
wow!! great job creating this analogy…i’m a financial advisor and am always on the lookout for new and interesting ways to explain financial planning to clients…really good!!
I would love to see one of those fun apps that lets you input your info and then determines what kind of fort you are (You are a straw shack blowing in the wind, why don’t you “build an outer wall” (link to example info for emergency accts)). Hmm.. maybe I’ll build one
I’d suggest working on the outerwall first. It’s hard to put up scaffolding when you keep falling into the moat, not to mention the nature of the ebb and flow of a moat makes it hard to get to a point where you feel you’re ready to start building the wall.
Great post!
Great analogy, I need to put my guards on furlough though, they have been seeing too much action.
This was great! I feel like you should put it all together into a fairy tale story.
Where are you getting 5% with a online saving account?
Thanks!
I believe this is a repost of an older post (at least I think it is)
ahhhh. I get it. Thanks! Thought I was missing the boat!
Whoops, I should’ve updated that too. I went through and rewrote a large part of the post but managed to miss that bit. I wanted to refresh it and reintroduce it to new readers. This was originally published two years ago!
Yup, I’m that nerdy, I keep track of posts that Jim wrote two years ago…
I keep track of all my accounts with software. I personally use Mint – but Quicken and Wesabe are supposed to be good, too.
Great analogy! I liked how you used this one. It made sense and it works. Right now our guards are being paid off as well as we can. We’ve stopped adding to our outer wall for a bit until we get back to somewhat normal paychecks. For now it is waiting, hopefully we won’t have to have it come down any.
Ironically if you don’t pay off your guards enough (i.e. minimum payments), they’ll allow more enemies (interest charges) into your fort. This analogy is more appropriate than I think Jim thought it would be.
That’s definitely a wrinkle I didn’t think of… very clever.
Hey Jim,
Last year when we decided to move abroad, I realized the need to start gathering all the information for my ‘financial fortress’. There are just too many different pensions, 401k’s, rollover iras, credit union and other accounts. It’s great to spread the eggs across multiple baskets but you certainly don’t want to forget where one of those baskets is!
My tool of choice to keep track of this (and all the other random things in life) is Backpack. I really can’t recommend it enough!
I did this about two years ago too but my tool of choice is Excel.
This is a great analogy. I would have never thought that a fortress could be remotely similar to our financial situation, but it is.
this was really cool! very fun read.
Great analogy. Great pictures. I think I’d sell my car, and anything else I could get my hands on, before I raided my 401K