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You Can Save a Ton of Money With Financial Compartmentalization

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You Can Save a Ton of Money With Financial Compartmentalization

Using Only One Account Doesn’t Save

Many people were fortunate enough to take a vacation this summer, and some of them probably even journeyed to the islands: now it’s time to take your personal finances there using a method known as the Island Approach. But unlike a real vacation, this trip to the islands can actually save you a ton of money!

You see, the Island Approach is a compartmentalization-based personal finance strategy that entails using individual accounts for specified purposes in order to:

  1. accrue the best possible collection of terms for each type of transaction you’ll make, and
  2. garner a better perspective on your spending and payment habits.

No single financial account beats the rest of the market in every single category, after all. For example, a certain credit card may offer the most lucrative rewards, but won’t provide the longest 0% introductory period. Likewise, a particular checking account may waive all ATM fees, but isn’t likely to have the highest interest rates.

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What’s more, if you use a single credit card for carrying revolving debt and making ongoing purchases, or use a lone checking account for savings and everyday cash management, it can be difficult to determine what’s what and ultimately track your progress.

The Island Approach can solve all of that. It can also apply to any one segment of your personal finances, or to the full breadth – from credit cards and everyday cash management tools to investments and loans.

For simplicity’s sake, we’ll limit the following example of how the Island Approach could work in a practical sense just to credit cards.

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The Island Approach in Practice

Let’s say that you make the majority of your everyday purchases with plastic and currently have $6,600 in credit card debt (the national household average).

If you prefer the ease of using a single credit card, you’ll be forced to choose between:

  1. the most lucrative rewards your credit standing will allow you to get
  2. the most attractive financing deal, or
  3. average terms across the board.

You may also find it difficult to budget since your ongoing expenses are jumbled up with your revolving debt, which generally leads to higher interest payments. Interest is assessed on the average daily balance held on accounts with a revolving balance. When you use the same card to both revolve debt and make new purchases, your average daily balance will equal the sum of your debt and the new purchases.

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Interest will apply only to your revolving balance when you isolate debt and ongoing expenses. You’ll also give yourself built-in protection against overspending. We should all be able to pay off gas, groceries and other recurring expenses each and every month, so the presence of finance charges on the card designated for everyday spending will be a clear signal to cut back.

Then there are the improved terms. Rather than being stuck with one average card, you’ll be able to strategically take advantage of different market-best credit card offers. For instance, you could get:

  • The Slate Card from Chase (to lower the cost of existing debt): This balance transfer credit card offers 0% on transferred debt for the first 15 months and doesn’t charge either a balance transfer fee or an annual fee.  Assuming that you allocate $200 to paying down your balance each month, the Slate Card will save you nearly $1,800 in fees and finance charges while helping you become debt free nine months faster, compared to a regular card with a 17% interest rate.
  • The Blue Cash Preferred card from American Express (to maximize your everyday rewards earning): This card offers 6% cash back at supermarkets, 3% at gas stations and department stores, and 1% on everything else, in addition to a $150 initial rewards bonus for spending $1,000 in the first three months. Such rewards are not only worth the $75 annual fee for most consumers, but they’ll also enable you to effectively subsidize some of your most prominent recurring expenses.

You may even decide to get a bit fancy with the Island Approach and supplement your base cards with attractive one-time offers as they pop up. Issuers have made it a practice in the post-recession environment to offer lucrative sign-up rewards bonuses and financing deals. With the current offers in mind, you could get $400 in free money just by opening a card like the Chase Sapphire Preferred or the Barclaycard Arrival and meeting initial spending requirements.

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Bottom Line

The Island Approach is a personal finance strategy that entails using individual accounts to meet specific needs. It enables you to maximize your product terms, save money on interest, and keep better track of spending and payment habits.

However, there’s a reason it’s called ‘personal’ finance, and if you don’t think that keeping tabs on a number of different accounts will work for you, by all means opt for a more comfortable strategy. Just make sure to adhere to a budget and pay off debts as quickly as possible and you’ll be fine.

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