A framework to balance your income and spending into a manageable and sustainable system so you can make and automate better financial decisions.
There’s a lot of systems in my life. There are things to manage what I need to get done, to keep track of places I need to be, to document notes and stuff for reference. I even have a “pocket system” to make sure I have everything I need with me. One system that was lacking was something to help track and manage my finances. I don’t mean something like Mint.com, though that is an important piece of the puzzle. I needed a full framework that I could use to make smart decisions about how my income gets divided into short-term and long-term savings, and spending money and money for needs. I needed a method to the ways I spend my money. Should I put everything on my credit card and pay it off regularly? What about when I need to take out cash for the food truck? What account does that come from? The way I had been doing things for years was kind of working. Kind of meaning that I would get paid and I would pay rent and then by the end of the month everything else would be gone. I wasn’t month-to-month in that money was really tight; I was month-to-month as in I would meet my needs and then just spend everything else. I wasn’t broke but I wasn’t getting ahead.
I started following the blog Get Rich Slowly at the beginning of the year. Reading the ongoing posts and digging into their archive had me start thinking about the whys of money for me. If you’ve been reading my posts for a little while, you’ll notice that when I get to figuring out the why of something, the rest of the knot starts to unravel. I started to consider why I hadn’t been saving and why I didn’t think much about managing my money.
Without understand the why, I wouldn’t be able to go all-in with caring a lot about managing my money. I discovered why I was scared to save money: I want to take time away from my career to travel. Having money saved would be the catalyst that gave me permission to quit my job and go see the world. I was scared to drop everything to explore so I didn’t put money into that account. Money gives me the freedom to do the things I truly want and my scared subconscious was keeping me safe by keeping that account empty. I was also afraid that somehow being too conscious about money would make me focus on it more rather it just being a thing that exists which can help me do the stuff I want.
I want a certain level of security. I want to know that if something bad happens in my life or the life of a loved one, I would be able to support that situation financially.
I want to be able to put my money into things that are valuable and well made and beautiful and worth my attention. High quality things last longer but generally cost more up front. I want to spend less on the things I didn’t really care about, like fast food, so I can save for purchases that mean something to me.
I also want to be in a position that I can give freely. Sometimes giving money is just training to help teach ourselves about generous living but I also want to be able to put my money into the things I believe in. Part of this is giving to my church but I also want to have money set aside to be able to give to other people and projects that matter to me.
I want a framework that is easy to manage, both with income and spending. A simple system that’s easy to take care of and be partially automated would be maintainable and sustainable. Some extra thinking up front would mean I wouldn’t have to think about it whenever I stand at the ATM deciding which account to draw cash from. If I set things up right, I would never run into the issue where some pending purchase went through the same day rent needed to clear, bouncing the check. I don’t need a system to save for retirement or for investing but to help be aware of my finances and provide constraints and simplify managing my money.
A Game of Percentages
For me a standard budget never seemed to work. It didn’t make sense to me to put aside
x dollars a month for entertainment even if there weren’t good concerts or movies out that month but I really wanted to be eating out more. I’ve always been more flexible with my spending where sometimes I’ll go out less and save up for a bigger purchase. I needed a framework to work within rather than a budget.
The Balanced Money Formula seemed to be that method. It suggests that your needs shouldn’t be over 50% of your after tax, pocketed income. Savings should be at least 20% of your income and you can do what you want with the other 30%. This made a lot of sense. If I wanted to eat ramen every night so that I can save for some cool thing that’s costs 30% of what I made that month, that fits in the framework.
I took a look at my bare necessities, as the formula suggests, and that came out to 45% of my income. That’s things like rent and utilities, student loan payment, paying off some credit card debt, and groceries. I’d rather it be closer to 35% but I partially blame the costs of living in Manhattan and that I factored debt repayment into being a Need, at least for the next few months. I wanted to push myself to save more and create a constraint around my free will spending so my formula has Saving up at 25%. This leaves Wants down to 20% because I factored 10% (a tithe, if you will) of my income to giving. A good chunk of that Giving money goes to an offering to my church, while some goes to support my sister in the missions work she does, and some gets set aside for miscellaneous giving. If you don’t have a church or feel that’s not your thing, I encourage you to budget some giving into your framework anyway. Being generous is one of the few great things we can do as human beings.
So, the “in” part of my framework—the buckets that income gets put in—looks like this:
- Needs: 45%
- Savings: 25%
- Wants: 20%
- Giving: 10%
Can’t save 25% of your paycheck? That’s fine. How about 2%? Anything is better than nothing and it’ll start to get you into the habit of automating your savings.
Buckets for Money, Not Buckets of Money
Figuring out how I should be divvying up the money I make is only part of the framework; I also needed a place to put the money that fits with how I wanted to spend it (or not spend it). I’ve always liked the idea behind the Envelope System, where you put cash in different envelopes for the different categories of your spending budget and when that envelope is empty, you’re tapped out of that area of spending. The cash-in-an-envelope part wouldn’t work for me but part of the logic does.
I have four bank accounts set up to be my different “envelopes.” I have a checking account for Needs, a checking account for Wants, and two separate savings accounts both for Savings and an Emergency Savings account. My work allows me to do direct deposit of my paycheck into several different accounts at whatever percentage or dollar amount I request, so all of the “in” percentages get deposited into these accounts. If you get paid by direct deposit, ask your employer about getting it deposited into multiple accounts. If they can’t, or you don’t get payed by direct deposit, schedule automatic transfers from your main checking account out to your other accounts. Automation is an important part of this framework.
Here’s how my accounts work:
Needs Account: This account is where the 45% of my income goes into and where just comes right back out for rent and groceries. I use USAA, an online bank with great reviews, but any checking account will do. For this account, I needed checks for rent and a debit card tied to pay for groceries and any other Needs that weren’t automatically drawn from this account. I’ll talk more about using credit cards vs. debiting directly out of accounts, but briefly, I felt like I should be buying basic needs with real money—money I had—rather than credit. When I’m at the grocery store, I pull out the card marked Needs and swipe that rather than cash or credit. I’ve also tied my needs account to Paypal so that I can give to my church online and it will come right out of this account.1
Savings Account: I have two ING Direct high-interest savings accounts that I use for my Savings and Emergency accounts. I chose this system of savings accounts (rather than something like Bank of America or TD that offer both checking and savings together) because of the benefit of the higher interest rates and because they were separate. I can’t just cheat when I’m at the Apple Store and buy whatever’s new and hot by swiping my bank card and choosing the Savings Account button. I can still transfer money out of my savings into a connected external bank checking account, like Wants, but it takes a day or two which helps reduce impulse purchases out of savings. The emergency account acts likes standard savings account, but usually holds a minimum of $1000 or a months pay that just sits there in case something bad happens and you need money for hospital bills, or a flight to see family, or whatever emergency may come up without having to tap into credit debt.
Wants Account: This is another standard checking account that has a separate debit card. I don’t need checks for this account because who buys things with checks? When I get tacos for lunch or go eat out at a fancy restaurant, I use this debit card. When I go see a movie or buy train tickets to get out of the city for the day, I use this card. I can get cash out for the ice cream truck or for late night street meat with this card. The best (and worst) part of this? When it’s gone, it’s gone. I can run this account to $0 (Aside: Don’t set up auto-overdraft transfers. They come with hefty fees and you need to learn that when it’s gone, it’s gone.) and I know that my rent will be paid and I won’t go starving since my groceries come off of my Needs account. If I want to buy something big, I can let this account grow for a few pay periods and use that money to buy something fancy. This account will see the most transactions and probably the most abuse, but I’ve allowed for that to happen while protecting the things that need to clear.
Is having all these accounts messy or complicated? Not really; the automation takes care of most of it. Hopefully, you aren’t touching your savings often so that leaves just your Needs and Wants. I think having two checking accounts actually makes it easier to manage and the built-in fail-safes of not overspending and missing rent makes any additional management worth the time you’d otherwise spend worrying.
Credit Card or Debit Card?
Noticed how I haven’t said much about credit cards yet? I don’t think they’re that important to the framework. They should be a payment method for the money you have, not a magical money printing device. Credit cards are important though. It matters to have a credit history and spending on a credit card can give you things like cash-back or travel rewards and insure your purchases. But they can also cause a lot of problems since it’s so easy to get yourself in trouble with them and to rely on credit for money that you don’t have, don’t have yet, or won’t ever have.
I’ve reduced spending on my Visa greatly in the past couple months while I get more comfortable with this framework and get a feel for how the balances look at the end of the month. I still do use the card sometimes but have my Wants checking account set up to pay off recent spending that classify as Wants and my Needs checking account set up to put money towards paying debt. I still have some sites like Amazon tied to my credit card, though I could attach my Wants account.
Since I’m a Canadian abroad in the States, I don’t really have any credit history. I was lucky to get this Visa card in the first place and want to continue to build good credit here. For me in the next several months, I’ll rely more on my debit card and spend money I know I have rather than buy on credit and put off zeroing out that credit balance with money from my Wants account. It’s not that credit cards are bad, but for now, using it less is easier for me to manage, track, and understand my spending habits.
Tracking Where Your Money Goes
Tracking “every penny” is a core part of any money management system. I actually have found this the easiest part thanks to Mint.com. Once you do the initial set up, it does a lot of the work for you. You just need to remember to go in—I do it once a week—and review things like uncategorized transactions and that your spending categories seem to be on a normal trend. Put this as a recurring task into OmniFocus or your GTD system, if that’s a thing you do, so it doesn’t get forgotten.
Making It Work For You
Finances are a pretty personal thing. With a wide range of incomes, needs, debt, and financial responsibilities, it’s hard for one solution to work for everybody. This framework isn’t meant for everybody but I think it might fit for lots of people. The important part is that it’s a framework. Frameworks are concepts, an architecture to work with and work around. Things like your Needs, Wants, and Savings percentages can be adjusted for what works for you. The financial struggles I face are probably common ones and maybe at least some of the ideas in this framework can be applied to create a system that helps money free you to do the things that you want to do.
My “Giving” funds living in my “Needs” account for now, because I haven’t thought of a better way of doing it. I guess I could open a third checking account. ↩