Financial Autopilot

"For every minute spent in organizing, an hour is gained."
- Anonymous

My checkbook has been on financial autopilot for so long now, it's hard for me to imagine it any other way. I spend almost no time at all paying bills, timing my cash flow, or remembering due dates. This enables me to focus more time on my investments, my career, and my family.

My system consists of two simple parts:

• Automated clearinghouse (ACH) debits and credits
• Overdraft protection

For each recurring credit or debit in my life, I signed up for "direct deposit" or "automatic debit" directly from the company involved. This includes my:

• Paycheck
• Federal Tax Refund
• State Tax Refund
• Mortgage
• Telephone
• Cell phone
• Internet Service Provider
• Water/Sewer
• Electricity
• Gas
• Trash
• Auto Insurance
• Others

Note that this involves contacting each company and providing authorization for them to credit or debit your account. For a few years in the mid 90's, I used (what is now called) online bill pay where you control everything from your checking account. I didn't find this approach to be satisfactory at all, as it only seemed to eliminate the postage stamps. First of all, the online bill pay paradigm still requires you to remember to schedule all of your payments. (Most of my monthly bills are not a constant amount of money, and many of the due dates also vary from month to month.) Second, in the case of any billing or payment dispute, the introduction of a third party can be a nightmare for any timely resolution of the problem.

The second part of my system is to attach overdraft protection to my checking account. I've had overdraft protection since 1991, when I opened a revolving credit line with my bank specifically for this purpose. (The bank offered it to me when I opened the checking account.) About 10 years later, I decided to simply attach my HELOC (home equity line of credit) as overdraft protection to my checking account. If you don't have a proclivity to rack up debt, this is a truly great tool.

I don't think I could make the automated clearinghouse transactions work effectively for me without the overdraft protection. The payments are often very uneven and biweekly paycheck deposits don't always time correctly with monthly bills. Thus, if you let all these debits happen automatically and you don't want to bounce anything, you either have to spend a lot of time tracking everything very deliberately, and/or you have to maintain a large checking account balance as a cushion. I don't like either of those options.

Hence, I just have the occasional overdraft onto my HELOC. As soon as I realize there is a balance on my HELOC and I have the money from the next paycheck, then I completely pay it off. For you debt avoiders out there, this is not as bad as it sounds. I only use the HELOC as a bridge to even out my cash inflows and outflows without worrying about what my checking account balance is every single day. I don't use it to borrow money for more than a few days. When used in this way, the interest expense is very minimal. For example, if I overdraft $200 for one week and then pay it off, the interest expense is about 30 cents. (There are no fees involved - only interest charges.) Even if I did this once a month, my yearly interest expense would be less than $4. This is a bargain when you consider that you are giving up $5/year for every $100 you keep sitting around in a checking account versus a brokerage money market account - and perhaps even more, if that $100 was allowed to flow through to longer term investments. I've used this system for a very long time, and even in years where I was very sloppy about recognizing and paying off the overdraft balances, I think I still always incurred less than $10/year in interest.

So to summarize the advantages:

1. Saves time. There are no trips to the bank and the post office. No time is spent writing checks. No time is spent scheduling the payments. It also allows me to block together all the record keeping to once a month, which is also a more efficient process.
   
2. Saves money. I probably save about $50/year in postage. There are no bounced check fees ever. There are no late fees ever. At nearly all times, there is very little in the checking account. Instead, the money is earning much higher rates of return elsewhere. And of course the big bang for the buck is with the opportunity cost - the ability to have the time to make a substantial difference in income through focus on one's career and investments.
   
3. Reduces Stress. There is no need to remember payment due dates. There is no worry about any of this when you are sick or on vacation or swamped with the occasional 65-hour work week. There is no fear of embarrassment from possibly bouncing a check, and no worry that somewhere in one of the piles of papers there is a forgotten monthly bill lurking.
   

This is not rocket science. Anyone can do this very easily, but I find very few people do. Certainly there may be good reasons for someone not to use this approach. For example, if you don't have very many recurring bills, it might not be worth the effort. Also, if you have issues with spending control or debt control, overdraft protection of your checking account might play to your weaknesses. (Imagine what a $140,000 HELOC attached to my checking account might do if I had problems keeping spending under control!) And some people do not like the "pull" paradigm of giving authority to another entity to take money out of your account. Or maybe you simply have a better system for yourself that saves you even more time and money. (If so, I'd love to hear about it!)

When talking with some people, however, their objections to this strategy often seem to me to involve various mental accounting errors. For example, one friend who continues to occasionally bounce checks does not want to consider overdraft protection because he "will absolutely not pay one cent of interest." A $25 bounced check "fee" is compartmentalized separately from a 30 cent "interest charge". Another friend does not want utilities debiting his charges from his account because of the way in which he tracks his expenses. As near as I can tell, the thinking is that if an automatic debit notice came in the mail, he would account for that immediately so he wouldn't lose track of it, even if the debit date occurred a few weeks later. With an online bill payment, he accounts for it at the time he schedules the transaction. Thus, if he can perform the transfer action a few weeks later than the arrival of the automatic debit notice, he somehow feels wealthier. This makes no sense to me as a $50 electric bill debited on May 30 is still the same in both scenarios, regardless of whether the automatic debit notice comes May 1 or whether you go online May 29 and tell your bank to transfer the money the following day.

So if you use a different strategy, just make sure it's for one of the right reasons I outlined earlier. Otherwise, if this system is something workable for you, you may want to consider it. I can't even begin to tell you how great it feels to let the bill paying take care of itself and allow me to concentrate on bigger things in life.

Mental Accounting Errors

"Thence came forth Maul, a Giant. This Maul did use to spoil young Pilgrims with Sophistry."

- John Bunyan

An understanding of the term mental accounting can help with spending, budgeting, and investing decisions.

Mental accounting is a type of framing where people mentally divide their assets and income into buckets. Depending on the particular mental account, vastly different decisions are made regarding the money, even though money should be exchangeable. The behavioral economists who study these things mainly seem to be interested in trying to predict and explain behavior, so they don't necessarily label mental accounting as a negative thing. There can indeed be some positive aspects to mental accounting. However, when a particular mental accounting decision has a clear negative impact on current or future net worth and there appears to be no rational motive for it, it is sometimes referred to as a mental accounting error.

The classic example of a mental accounting error is when a person maintains a large credit card balance at 18% while also maintaining an even larger checking account balance earning 1% that could be used to eliminate the debt. For some individuals, even if they are aware of the money that could be saved, they may choose not to do so because the checking account is viewed as "savings" or an "emergency fund" that cannot be tapped. For other individuals, the high checking account balance in isolation may make them feel wealthy, and a reduction of the account would make them feel less so. I will confess to such an attitude when I was in my early 20's, and thus I continued to make this error for a year or two.

Now you may be thinking you would never do something so stupid. Lest you get too smug, I would point out that many other mental accounting errors are extremely subtle and even the people who are experts in this field admit to making such errors.

Here are some more recent mental accounting errors I have made and corrected:

• Treating each account separately. I used to diversify each of my accounts individually instead of across all accounts. I did this because I didn't want any particular account to have a high volatility and because an individual account statement would otherwise look too concentrated in a couple of positions. This is definitely mental accounting, separating my money based on account. However, if the accounts are similar in nature (e.g. three different IRA accounts), then this is usually detrimental to net worth for no reason. It results in higher fees since the position sizes are all smaller. I had to train myself to avoid looking at each individual account in isolation, and instead look at my total portfolio across all accounts. This saved me money.

• Treating fees separately from all other money. A lot of people have a real attitude about fees. Anything labeled as a fee is treated as an evil to be avoided literally at all cost. My emotional side gets worked up about fees as well, but I have often found it's cheaper to pay them than the alternatives we choose. For example, suppose you find yourself in need of cash and the only nearby ATM is not your bank, so you will have to pay a $2 ATM fee. If you then drive 5 miles to your bank to save the $2 fee, you probably will spend more than $1 in gas on the 10 mile round-trip. If you have a newer vehicle, you also probably incurred way more than $2 in depreciation and wear and tear on the vehicle. (The IRS would consider your 10-mile trip to cost you $4.85, and the estimates from AAA are in the same ballpark.) I used to spend $5 elsewhere to save $2 on ATM fees because I hated the fees. The fact that "$2.00 Terminal Fee" is immediately printed on the ATM receipt highlights the fee, while the fact that the gas and maintenance outflows come later obscures the alternative costs. ATM fees were just the tip of the iceberg; I learned to be careful about all sorts of fees and their alternative costs.

• Treating the same amount of money differently depending upon context. We often tend to view a particular amount of money based upon the surrounding context. For example, if a coffee maker that we are interesting in purchasing is always seen selling for $39, and we suddenly find it selling at a particular store for $19, we spend time and effort to obtain it at that price. After all, it's 50% off! On the other hand, if a dining room set normally sells for $1999, and we see it for $1979, we are unimpressed because the percentage different is small. Yet $20 is still $20 regardless of context. The biggest lesson here for me was not to disregard comparatively small savings when making large purchases.

For further reading about mental accounting, I would recommend Richard Thaler's Mental Accounting Matters (Warning: 2.4 MB pdf file). It's not an easy read, but it's very interesting and informative.