Financial systems are “set it and forget it” applied to your personal finances. They are valuable because they save you from having to worry about your money. For example, instead of making a decision to save each month, it happens automatically. It helps you focus your attention on things that do matter, like creating value for other people.
My favorite guide on creating systems for personal finance is by Ramit Sethi, called The Ultimate Guide to Personal Finance.
In it, Ramit talks about a prescriptive budget and a descriptive budget. The descriptive budget is where your money is currently going. Due to my obsessive tracking of my expenses in Gnucash, I already had this. Do you need to be like me? Probably not—there exist tools like Mint.com that can aggregate various spending accounts into one convenient place.
A prescriptive budget is a plan for spending each month. Here’s one way to create a spending plan:
- Fixed costs: things like rent, utilities, debt
- Investments: your 401k and Roth IRA contributions
- Savings: Build up an emergency fund if you haven’t already. Otherwise, this is for accumulation fund for things like vacation, house down payments, etc.
- Guilt-free spending money: Groceries, eating out, shirts from REI, movies.
Then you want to create systems that automate the categories in your prescriptive budget. That way, you spend less time worrying about money and more time enjoying the guilt-free spending money.
Does that sound like more fun than constantly worrying about financies? If so, head on over to The Ultimate Guide to Personal Finance.
3 Comments
We’ve been doing this with YNAB over at http://youneedabudget.com
It’s truly an eye-opening mindset. My wife and I sit down once a month to talk about what we’ll spend money on next month. Then, we spend it! No second thoughts. We allocate the money, and the money is there when we need it.
I’ve done this for years thought I tend to take it to the point of automation such that I never need to worry about missing a bill or expense.
Here’s how I do it. I get paid every two weeks, on Friday. Most of my bills are at the beginning or the end of the month. There’s about 4 weeks in a month, so I cut the bills in half and push that into a separate checking account the moment I get paid. I have automatic transfers setup to do this. This means that all of my “cannot miss” bills are accounted for. I do the exact same with savings, but the conversation is a little different. It’s more about “how much should I have left in my daily checking account” vs “what’s my saving goal I’m pushing for.” with consistently managed money I know exactly what I have an don’t have, though so considering where to save more or less is about turning a dial – not resetting and considering the entire budget every time I want to adjust.
So, I have a Daily checking account (normal spending) and a Bills account (only touched via automated in/out billing or mortgage payments). The separation is really a big piece for me. I also have a savings account which is used as more of a buffer for minor emergencies (suddenly $4k repair on a car kind of thing) paired with the credit card. I send all external money movement through the Bills checking account – even my IRA and Investment transferring (which is automated all the through to those account) so that when I wake up on Friday and check my account, everything in my daily account is available to me to spend through the pay period.
The mentality transformed my peace of mind as well as my perspective on what I’m making already.
Sorry for the rambling. Whenever people talk about improving personal money management – this is a key thing and I was so excited when I felt I got it “right.”
This is great. I love how you said it becomes more about turning a dial, vs. starting over from scratch each month.
A great example of this is those bigger expenses like car repair. While they seem unpredictable in the short term, if you take a long term view they become predictable, and you can budget for them too. I found that car maintenance costs me $130 a month on average, so now I have a designated fund that gets populated by my paycheck and then depleted whenever I have a car repair.