I came up with the theory of four buckets when I was trying to explain to my sister in law how to better manage her money and make it grow by tweaking a few simple things. The idea was to picture 4 buckets sitting on the table in her house; the buckets would be labelled as follows: Transaction Account, Savings Account 1, Credit Card, and Savings Account 2. Every time she received her pay she would divide the money into the buckets, the buckets were a metaphor for banks accounts. The best place to start is to explain the purpose and use of each of the buckets and then finish with an explanation of how it works.
Just like a worker ant this is where all the hard work happens in terms of money coming and going and just like the worker ant this is where your money is most vulnerable to being squashed with temptation to spend. The first thing to know about Transaction Accounts is that they are not your friend they are your enemy, they provide you with interest rates less than 0.1% and they charge you fees.
The best way to manage a Transaction account is to only have as much cash as you would need in a week. When you get paid or receive money keep enough money in the account to last you the week and then transfer the rest into a high interest eSaver account. At the end of the week you can always transfer money back to the transaction account. By shifting your money weekly the money which is in the eSaver can gain interest and grow. I find that a balance of $200 in my Transaction account is often enough to get me through a standard week.
Tip 1: Money grows much quicker in an eSaver
eSaver Accounts have changed banking the same way that iPhones have changed the telecommunications world. When eSaver accounts first hit the market they were heavily restricted in terms of having to have a linked transaction account at the same institution (which you were charged fees for) and it was essentially a dumping ground with no ability to pay bills or easily access money. The eSaver has now evolved to accommodate Bpay, third party payments and also the ability to link the account to other institutions. The competitive rates of the esaver have also brought into question the need for term deposits.
Interest in an eSaver is often calculated daily and paid monthly; this form of compounding interest is favourable as it takes into account the balance of your account for every day of the month. By transferring money into an eSaver account at the start of the month and then withdrawing it to pay your bills, you can gain a level of interest which would have been missed if you had left your money in a Transactions Account.
Tip 2: Money in a Savings account uses compounding interest to help grow quicker
First step with a credit card is to pay it off, before you can benefit from your credit card you need to stop the credit card from benefiting from you. Now that you have a clean slate, find a credit card that works for you. There is a wide range of credit cards on the market so ensure you take your time shopping around. Try to get a Credit Card which has a low interest rate and a good rewards program, if you spend a lot of time in the car get a card which offers discounts on petrol, most rewards credit cards offer cash back offers, ensure you pay the money back onto the credit card or use it to offset your annual fee.
My credit card strategy is to use my Credit Card throughout the month for food shopping, petrol and other expenses and then pay it off at the end of the month. Always ensure you have enough money in your savings account so that you can pay off your Credit Card and not let the balance snow ball over a few months.
Tip 3: Always pay your Credit Card back to $0 each month
How does it work?
Step 1: Rough Budget
First step is to calculate a rough budget to understand how much you need to put away each week, this can be done by following the below steps:
- Group your Bills into Weekly, Fortnightly, Monthly, Quarterly and Annually
- Total each of the above categories ( you should now have 5 figures , Weekly, Fortnightly, Monthly, Quarterly and Annually)
- This example uses the assumption that you are paid weekly , Divide the fortnightly category by 2, you now have a rough weekly figure for these bills
- Divide the monthly figure by 4 to get a weekly figure
- Divide the Quarterly and Annually figures by 12 and 52 respectively
- Now add the 5 new totals together and you have a rough weekly total
Step 2: Setting up your accounts
When setting up bank accounts remember to shop around and read all the details in regards to the account. You will need a Transaction Account, 2 eSaver accounts and a Credit Card ( the Credit Card is optional).When it comes to eSaver accounts I like to have them at a different bank, this way if one of the bank changes their interest rate and the other doesn’t only one of your accounts will be affected. Link your Transaction account to both of your eSaver accounts so you can transfer money to both of the accounts.
The 4 Bucket Theory
The First Bucket is your Transaction Account, this account should carry a small balance and be used for your weekly expenses if you are not using a Credit Card and it should also be used for other cash sales.
The Second Bucket is your first eSaver account; this account is used for all your bills and a place to keep all your cash that you don’t want to keep in your transaction account. This account is functioning properly when there is enough money in the account to pay your bills when they are received.
The Thirds Bucket is your credit card; use your credit card for all your monthly spending including petrol, food shopping and other expenses. At the end of the month use your second bucket to pay the credit card balance back to $0
The Fourth Bucket is your set and forget account. Every week you should ensure you put money into this account. If you ask your employer they are often happy to transfer a portion of your wage into a different account. The objective of this account is to save for future large expenses such as buying a house or going on a holiday.
By using the theory of 4 buckets you will ensure that money which you are not currently using will be stored in a high interest account and grow at a much quicker rate. A low income earner who uses this method should gain enough interest to go out for a nice dinner to celebrate at least once every quarter.
Where to from here?
Once you have a large amount of money in your Fourth Bucket you could consider locking some money away in term deposits or investing in managed funds. Ensure you read into these accounts before you sign up. Aj's books has a range of great articles to help with term deposits.
Good luck and happy savings