How One Behavioral Scientist Optimizes His Monthly Cashflow
Take a look inside how Betterment’s behavioral scientist, Dan Egan, manages his monthly cashflow. Keep in mind, this is purely his method; not Betterment’s advice or suggestion.
I see holding cash in my checking account as a guaranteed small loss. So I minimize it.
I automate my budget and quarantine my spending from my partner’s spending.
I comfortably save for short- and medium-term expenses in low (not zero) risk allocations.
I try to spend very intentionally to help avoid lifestyle creep, easily one of the most dangerous parts of a long-term financial plan.
My background in behavioral finance gives me an unusual perspective on money. Take how I manage my cash, for instance. I focus on the system of my cashflow, and how that system works with my behavior. I try to minimize how much attention managing my cashflow requires; it reduces both stress and chances to make the wrong impulsive decision.
The median checking account balance in the U.S. is $2,900. As with most money stats, the distribution is very skewed: the mean (average) is $9,132. For people like me—people of my age, income, and location—the median checking balance is about $25,000. In stark contrast: I usually have less than $1,000 in my checking account, and generally end the month with $300 or less.
For some reason, I guess I’m not like people like me. Why is that?
Here’s the system I’ve developed over the years to maximize my happiness per hour spent thinking about money:
- Keep as little cash on hand as possible: Avoid inflation and impulse over-spending.
- Consider saving to be a bill you have to pay. Your spending is the negotiable part.
- Reduce stressful coordination problems with my partner by having three spending accounts (mine, hers, ours).
- Invest at low-risk levels for short- and moderate- term goals.
- Try to self-insure as much as possible (there are exceptions!).
Is there an art to using this system? Absolutely—read on.
Only my life’s boulders get budgets.
My budget is inspired by the golfballs and beer method of prioritization.
I only budget for the “boulders”—the large and/or recurring items I know about.
After that, I spend whatever I want, however I want. I do zero expense categorization/tracking; I have no idea how many coffees I buy. Not spending time on the small stuff can save stress, time and attention; it makes things more straightforward. Here’s how my budget looks:
I intentionally avoid some common expenses:
- I don’t have a car, which means no gas, insurance, parking, or maintenance.
- I don’t have cable TV, or a monthly transportation card, or a yard to maintain.
- I also have pretty inexpensive tastes, which makes it easier. Even though I’m not a hermit, a preference for inexpensive things is one of the best unfair advantages I have over people who struggle to keep their spending down.
Once that’s done, I only monitor my personal checking account for how much is safe to spend until the next payday.
One component out of my control is when I get paid: twice a month. This can befuddle certain monthly budgeting patterns, but it also means my personal spending is much more regulated.
The graph below shows the common pattern of my checking account balance over two years of monthly spending. A bump towards the beginning of the month, a spend-down till about mid-month, when I get bumped up again.
Checking Account Balance for Dan Egan
The chart above shows a statistical model of the author’s personal account balance data over twelve months, with each month’s data overlaid. We’ve removed the exact balance amounts to keep some of Dan’s information private, but as he explains above, he tries to keep his balance fairly low.
I irrigate my cash accounts, both checking and investing.
My cashflow system is set up to work automatically—and lets me spend as little attention as possible on managing my cash.
- Both my paycheck and my wife’s salary are deposited into a joint account. All the budgeted items above come out of that joint account.
- After our paychecks hit, two things happen:
- Our monthly savings is moved to our investment account where I have buckets for each of my goals.
- My personal spending money is moved to my personal checking account.
- I pay off my credit card.
- If there is excess cash in the joint account (say I get reimbursed for travel), I either pay off credit cards or an automated cash manager moves it to a ‘cash buffer’ goal.
I only look at or track my personal checking account. As long as I don’t go overdrawn, I’m ok.
I do put large and specific purchases on one credit card, mostly for the rewards rate and insurance. I clear that balance off when my personal spending money hits first. If the bill is particularly big—say from booking a vacation—then I can make a specific withdrawal from my reserve goal to pay off the credit card.
As a result, my monthly cashflow has a very regular shape.
This chart might give you a clearer idea of how cashflow works. This is completely hypothetical, representing an idyllic, regularized scenario for a checking account balance.
I don’t spend what I don’t have.
One of the hardest lessons I’ve learned is that I should bet against my own self control. I’ve never been able to save by not spending through the month, so I let my checking account balance be my self control mechanism.
I can always move money back to my checking account from a savings account if necessary, but generally I don’t. As the time since my semi-monthly paycheck increases, I just spend less and less. Daily notifications of my checking account and credit card balance helps a lot in this regard. Whenever my credit card balance gets above a small amount, I start paying it off while leaving enough cash to live off of. Then, the next paycheck I clear the credit card balance as a first step.
My Financial Goals
As I mentioned, I earmark my money using different goals to manage my saving. I have a waterfall of priorities I feel comfortable pulling extra spending money from as needed. Here’s a peek at some of the cashflow-related financial goals I have set up when I log into my saving/investing accounts. Keep in mind that this is what I’ve found works well for me, not necessarily what everyone else should do.
“Reserve Fund:” 100% Bonds
This is my “but what if I just minorly over-spend in any given month” fund. I have no qualms about making a withdrawal from this account to pay off a credit card bill, for example if I’ve decided to make an extra large purchase.
“Holidays:” 60% Stock Portfolio
This is mostly vacations, but also things like holiday and birthday presents. These are large annual expense I want to budget saving for, and then take out in big chunks each year.
“Just-in-case Fund:” 30% Stock Portfolio
For use if I’m unemployed, or we have big healthcare expenses. I don’t withdraw from this account regularly, but would be happy to if the need arose. It’s my ‘sleep at night’ and ‘margin of safety’ earmark.
“Charity:” 80% Stock Portfolio
I generally give about 10% of my after-tax income to charity each year via donating appreciated stock positions. I use a tool to help me automatically select tax lots for charitable gifts, which helps keep my giving straightforward for me:
- I make monthly deposits to a ‘Giving’ goal
- About twice a year, I make a set of donations to my charities
This both gives me optionality to make large contributions or give less if I find I really need the money through the year, and I run it at a high risk level to give maximize the gifting of appreciated shares.
Here’s how I invest over many short terms.
A common objection to my approach is that I might end up withdrawing when the balance is less than I invested. That wouldn’t bother me for two reasons: a margin of safety and my ability to see the ensemble.
The term margin of safety refers to the fact that for any individual case, I want to know I’ll have “enough” money, not that I’ll necessarily be up when I withdraw. So I usually have a buffer in my balance so that I can withstand an unlucky turn of events. For example if I want to spend $1,000 in a year on vacation, I’ll set up a plan to have a balance of $1,200. That way, even if I withdraw when I’ve lost money, I’ll probably still have the desired $1,000.
The second is that I see these recurring or ongoing goals as a single ensemble I’m optimizing over. Imagine that I was offered a 50:50 chance of winning $150 or losing $100: I’d probably reject that offer. But… I’d be willing to accept a bundle of 100 such bets.
I don’t get to make 100 vacation portfolios concurrently, but I can think of them that way because of my margin of safety. I’m effectively playing a positive expected value game 40 times over my lifetime with my vacation money. I know I’ll lose sometimes, but on average I’ll win enough to make it worth it. Being zen about the downside cases might be one of my superpowers.
Here’s why I self-insure, instead of buying as much insurance.
I do want to briefly touch on the benefits of self-insurance. Self insurance refers to when you build up a sufficiently large balance which you’ll use in case of emergencies rather than paying for insurance. For example, I’ve missed flights, but never bought travel insurance, because I have enough to cover the replacement flight.
Here are a few specific benefits to self insuring for managing cash:
- The funds are completely fungible: I can use my safety net for a missed flight or my dogs emergency care.
- I never have to process any claims, file any reports, or get approval from another company.
- I can invest the funds and they can grow over time, in case I never need them.
All of these make trying to self insure for smaller ticket items far more attractive than buying insurance for me.
Why does my cashflow approach work for me?
1. Maintaining Purchasing Power
I hate inflation. At least a market crash has the decency to show up in your balance. Inflation doesn’t tell you that it’s cost you. My approach means that on average I’ll outpace inflation, even if it means an occasional down year. I’d rather a positive expected outcome than a negative one.
2. No Regrets
Lots of people would probably be upset if they lost money over this short period of time. To me, that’s just part of life. I’ll win some, I’ll lose some, but on average I’ll be better off for having played. But I never risk more than I can comfortably lose.
3. Comfortable Margin of Safety
I can take more risk with my money because I have enough money to risk it, and not be destroyed.
4. Vaccinating Against Lifestyle Creep
Another superpower is avoiding a taste for expensive things: clothes, TV, shoes, food. I’m not a monk, but a PBR and a $2.00 slice of pizza make me pretty happy.
I also don’t have a car, and I bike or run to work. We buy a lot of things used: our strollers, furniture and food (just kidding!). My wife cuts my hair. I get lunch at work, and fast two days a week. I use our local library and Libby to borrow books I’m not sure I want to buy.
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