Through a relationship with Charles Schwab, you gain access to Schwab Bank’s High Yield Investor Checking account. Schwab Bank is technically a separate service provider, but is overseen by its namesake. One of the best features of this checking account is free overdraft from your connected brokerage account.
When you set up a Schwab Bank checking account, you link it to a Schwab brokerage account to enable overdraft protection. If you make purchases against your checking account which is more than the balance of the checking account, Schwab will automatically transfer money from your brokerage account to the checking account to close the position.
By using just this one feature while carrying a $0 balance at Schwab Bank, here is how you can structure your finances to more fully stay invested.
Overview of Strategy
How does it work?
Schwab’s free overdraft protection means that your Schwab Bank account serves like a pass-through account.
The first step is to carry a $0 balance in your checking account and functionally forget that it could ever hold funds. Treat the checking account like a secondary account number you can use to protect the true identity of your brokerage account.
With a $0 balance in the checking account, you can then use the checking account to establish automatic payment at other vendors or use the debit cards, checks, and bill pay available through the checking account to withdraw funds. As those withdrawals come in, Schwab will seamlessly pull cash from your brokerage account to meet those spending needs.
Under this strategy, you can bank with greater peace of mind because, in the event that your Schwab Bank checking account number is compromised, you can simply close that Schwab Bank account and open a new one without any affect on the brokerage account that really has your money.
Additionally, you or your investment advisor can seamlessly invest any funds you do not spend. Unspent funds never leave your Schwab brokerage account, so keeping your account invested is the default.
If you ever need funds beyond what has been staged in cash, you can sell investments and have the cash ready for withdrawal the next day.
If you need the funds even sooner and if your brokerage account has margin features, you can automatically get a short term loan against your investments while you await the settlement of your investment sales.
Why does it work?
The main pitfall of our traditional implementation of the Automatic Millionaire is that once the funds leave the brokerage account for an external checking account they never return again.
In the best case scenario, those funds don’t return because the MoneyLink is so perfectly matched to your spending that nothing extra is left behind.
In the real case scenario, those funds don’t return because putting the money back into your brokerage account is a manual process. It requires first noticing that there are excess funds accumulating in the checking account. Next, it requires putting some funds back. Then, it requires reducing the monthly MoneyLink which is building up the excess balance.
All those steps — noticing, transferring, and reducing — don’t feel worth it when the cash balance is small. However, by the time the cash balance has reached $100,000, you have already missed out on months or years of investment growth.
By spending out of the brokerage account directly, you are able to avoid this pitfall entirely. The funds do not leave the brokerage account for an external account until you are spending them. If you don’t spend the funds, then the excess will be invested.
How to Implement
Step 1: Directly deposit all your income into your brokerage account.
The best way to ensure that you save and invest is to automate the process. For our clients, you’ve already got the investing automated by working with Marotta Wealth Management. Now, you just have to automate the savings.
This is accomplished by directly depositing all of your income into your brokerage account. Include all income sources like wages, paychecks, Social Security, pensions, or immediate annuities. When filling out all the necessary paperwork, Schwab provides a helpful PDF you can use to get the right information to the right people; we discuss this PDF in our guide “How to Set Up Direct Deposit.”
Step 2: Identify how much cash you need on hand for expenditures.
If you know what your monthly standard of living is, then determining how much cash you need for one month of spending is simple. You can simply review your projected cash flow — all your deposits minus your projected withdrawals — to determine how much you need on hand for your spending.
If you aren’t sure how much you spend, there are a few strategies. You could use the amount you hope your standard of living is and then find out if you can live on that. Alternatively, you could set your one month cash to 75% of what you are depositing. This leaves 15% for retirement and 10% for unknown expenses.
If you are net withdrawing from the portfolio, we recommend keeping 3 months of net withdrawals in cash with the next three months after that in a money market mutual fund.
For example, if you are contributing $0 to the account each month but withdrawing $4,000, we’d set your cash target at $12,000 and your money market mutual fund target at $12,000 for a total Short Money allocation of $24,000.
If you are net contributing to the portfolio, you can afford to keep the smaller cash target of just one pay period worth of spending.
For example, if you are contributing $6,000 to the account each month and plan to spend $4,000, that is a net contribution of $2,000 per month. You can afford to set $4,000 as your cash on hand. This means that you’ll have $4,000 of cash which you gradually spend down over the course of the month. Then, a fresh income deposit will arrive to replenish the cash. $2,000 will be invested and the remainder will gradually be spent down again over the course of the new month. This cycle will repeat again and again.
If you spend less one month, the excess will be seamlessly invested. If you need to spend more in another month, either cash can be generated from the investments or spent from next month’s deposit to meet your extra spending needs.
Step 3: Automate the investing.
We strive to keep our hand-traded accounts as fully invested as possible. After communicating your withdrawal needs to us, we make trades to generate cash to meet those withdrawals. If you have surplus funds from deposits or dividends, we make trades to invest the extra cash according to your asset allocation.
This cash flow management service means that your monthly required minimum distribution, the direct deposit of your automated savings, your quarterly estimated tax payments, and other expected cash flows can use our trading to prepare for either withdrawal or investment in the markets.
By default, we strive to keep 6-months of planned or regular withdrawals in cash. Anytime you need to withdraw funds beyond those planned withdrawals, a simple email to our team means that we can both generate more cash and make sure our trading does not interfere with your transfers.
If you are a client of ours and are interested in getting started with this strategy today, we’d love for you to fully utilize our Cash Flow Management services and would be glad to assist you in identifying your income sources to directly deposit, setting your cash target, and monitoring the implementation of this strategy.
Photo by Paige Cody on Unsplash. Image has been cropped.
