How to Get Out and Stay Out of Debt
Part 4–The Planned Reserve & Resetting the Expense Counters to Zero
The problem with the combined paycheque-to-paycheque and month-to-month approach to personal budgeting is that you end up saying stuff like, “Oh, well a huge chunk of this paycheque is going to get eaten up by rent (or the mortgage)” and “This paycheque has to cover those bills that come due X number of days after payday but Y days before next payday.” It’s a terribly reactive, “putting out the fires” approach and, while it’s arguably a kind of planning, it’s too short-sighted.
What happens with this approach is that whatever is left over after you deduct those amounts from your paycheque is what you’re likely to fritter away because you’re incorrectly going to assume that’s your discretionary income. Combine that big mistake with another doozie, which is to exclusively trust what the bank tells you is the balance in your account without thinking carefully about what did clear your account and what will clear your account soon, and the only epithet that can be ascribed to your personal financial style is indeed “reactive.”
Indeed, that’s NOT your discretionary income and that’s NOT how much money you really have in the bank, and therein lies the problem. What’s left after paying the next bills is money you should be setting aside incrementally for later rather than spending now, and the balance the bank is reporting back to you is only a snapshot in time — a mere sentence in a story being told to you by a very accurate but uninspired bean counter. You need to break free from these two terrible financial trompe-oeils.
Putting Out Fires Without Seeming To Be Doing So
The question I really wanted answered when I began budgeting is, “How much money do I need to have at any specific point in time?” I wanted to know how much money comes in and when and how much has to go out and when so that the sums needed will be ready when they need to exit my account.
Ideally, what I wanted to make my life easier is to pay everything that needs to be paid in the course of the year on payday — 26 times a year.
— I need to pay you $X per year? Here’s $X / 26 today.
— I owe you $Y every year? Here’s $Y / 26 today.
And so on.
That ideal was just that: an ideal that could never be turned into a workable idea, because who I am to single-handedly change how the world does business just to cater to my quirky desire? Or could the spirit of this ideal be made to work in the real world?
So I started to think about having dividers in my bank account, an idea I freely admit was inspired by Gail Vaz-Oxlade‘s “magic jars” except that I visualized my jars as being electronic and I wouldn’t be filling them up front with the amount of the next payment in that category.
Indeed, I wanted to have something like “sub-accounts” within my account so that I would be able to say at any time, “This amount is how much I have set aside so far for the next rent payment” and “This amount is how much I have set aside so far for my next dentist’s appointment.” I wanted ONE number for each big category of needs as if I were able to make an installment on each on payday, but instead I would squirrel away each amount it its own divider so that it would be ready when the time to pay would come. If only I could figure out the amount I should have in each category right now and applied that theory going forward, none of my sub-accounts would ever go below zero, right?
There were only two problems with this idea as I pondered it for a little while.
- I couldn’t set up such virtual dividers in my account — at least at my bank and I doubt at any bank — and having a separate account for each need would not only be unmanagable but probably would also be disallowed by the bank.
- It seemed rather silly to have a “large” amount of cash sitting in a regular chequing account that returned no interest on deposits, not to mention that I could, in a moment of inattention, become a victim of the second trompe-oeil I mentioned above.
Those weren’t really problems, though. I would just have to represent my dividers on a spreadsheet, and the bank not only allows me to have a separate savings account that gives a bit of interest on deposit but also permits unlimited transfers back and forth between my chequing and savings account. So on each payday, I need to know exactly how much I need to set aside (the sum of all my needs) and exactly how much will be payable in the next 14 days. If the former is larger than the latter, I move the difference to my savings account, and I transfer in the opposite direction if the latter is larger than the former.
Thus that savings account, which gives me ridiculously-low-but-better-than-nothing interest on deposits, has become my “reserve” bank account, and I have a spreadsheet tracking it with all my wonderful “needs” category (see Table 1). Each category of fixed expenses has two columns: the first to enter money being deposited or taken from that category and the second for the balance within that category. Each payday has two rows: one to deposit the amounts and one to withdraw the amounts. And there’s an extra row for the first business day of every month to record the interest that the bank pays me, which goes into a “contingency” savings set of columns that I try to keep at $1,000 at all times. Despite what I’m about to tell you below, I recommend that you give yourself that float even if you’re in debt repayment mode.
The “Reserve” Account: Implementing the Yearly Approach to Budgeting
You need to find a point in time — normally a day or two before the payday when you want to start your budget to get out and stay out of debt — to set the counter for each of your need categories to zero — that is, make sure you have what you ought to have right now in each category.
To achieve this, you need to find out exactly how much cash you have on hand at this moment, excluding what should have cleared your account but hasn’t yet for whatever reason. That amount might be insufficient to reset your counters to zero but you’ll just have to borrow the difference. That idea might sound crazy on the surface but that’s exactly what you would have done before you embarked on the budgeting backwagon, except now you’re promising to yourself that this is going to be the last time you’re ever going to borrow from Peter to pay Paul.
As I mentioned in Part 3 of this series, if you have any accessible savings, namely those that aren’t tied up in an RRSP or non-refundable GICs, you need to count them as “cash on hand” because they have no significance when you owe far more than what you have.
So true is this statement that even if you do have a non-registered, non-refundable GIC, you should think long and hard. Isn’t it worth foregoing the interest for cashing it in before maturity if doing so will bring the date you’ll be reaching debt-free status closer, and by how much would you be delaying that date if you don’t cash it in now? How much more interest will you have to pay on your debt for not putting this GIC in the till now? Indeed, the odds are virtually nil that you’ll earn more interest by leaving that GIC mature rather than cashing it in now. If this non-refundable GIC is with the same bank as where you have (or are planning to have) your LoC, you might have more luck in being released from such a GIC, especially if the bank knows what you’re trying to achieve and understands that you’re not just being a flake.
Table 1–The Reserve Account
In this example, I’m pretending that I’m starting my budget on the period of 10 Nov 2016. I’m only showing 3 categories due to space limitations and I’m skipping the monthly row where I record the interest I receive and automatically move to savings.
I currently have 13 “needs” column set in my real spreadsheet. The last set of columns — with three columns instead of just two — allows me to manually enter whatever is left over from the paycheque that will go toward debt repayment (when you’re paying off debt) or savings (once you’re in the clear). Plus as I just mentioned, I also keep a loose $1,000 in this account as a contingency fund that I can dip into for unforeseen expenses, which I bring back to $1,000 as soon as possible even if it means less debt repayment (or real savings in my case) during the next period or two.
The first step is to go down the “+/-” column, one category at a time, to enter as a negative the amount that must go out (that is, be returned to your chequing account) in each “Amounts due” row — but leave it blank if nothing is to come out during that period. To do this, I found it helpful to map it out on a sheet of paper. On the page, one row represented a category and, next to it, I would list the due dates. For example, I had “Electricity: 17 Feb, 17 Apr, 17 Jun, 17 Aug, 17 Oct, 17 Dec,” but I simplified in cases like “Rent: 1st of month” or “Car Insurance: 19th of month.” I also had a perpetual online calendar handy to keep track of when those dates fell on a Saturday, Sunday or holiday so that I could advance the date of payment to the next business day, which sometimes meant that a payment due at first glance in a given period should be advanced to the next period. This is more likely to happen around end-of-year holidays.
Then, go back to the top and, in the same category column but in the “Reserve” rows, enter the amount that should have been contributed by paycheque (see Table 2). The further into the future you go, the better, although I don’t know too many people who are as compulsive as I am and will go 10 years ahead.
By the way, the “Floor” cell for each category has a formula to find the smallest value in that category’s “Bal.” column and you will use it to ensure you never go down below 0.00 in that category.
|09 Nov ’16||RESET TO ZERO||256.87||256.87||207.60||207.60||27.72||27.72||21.55||21.55|
|10 Nov ’16||Reserve||486.93||743.80||415.40||623.00||55.38||83.10||16.15||37.70|
|10 Nov ’16||Amounts due||0.00||743.80||623.00||83.10||37.70|
|24 Nov ’16||Reserve||486.93||1,230.73||415.40||1,038.40||55.38||138.48||16.15||53.85|
|24 Nov ’16||Amounts due||-1,020.00||210.73||-900.00||138.40||-120.00||18.48||53.85|
|08 Dec ’16||Reserve||486.93||697.66||415.40||553.80||55.38||73.86||16.15||70.00|
|08 Dec ’16||Amounts due||-70.00||627.66||553.80||73.86||-70.00||0.00|
|22 Dec ’16||Reserve||486.93||1,114.59||415.40||969.20||55.38||129.24||16.15||16.15|
|22 Dec ’16||Amounts due||-1,020.00||94.59||-900.00||69.20||-120.00||9.24||16.15|
For each category set, the “Floors” cell should show the lowest amount in that column, which is most likely a negative. Enter that amount as a positive in the cell at the intersection of “RESET TO ZERO” and “+/-“.
Then, if you notice that the balance in that category never goes back to 0.00 after the first time, you can reduce the amount in the “Reserve >>> +/-” directly above the smallest balance by the amount of that balance. Indeed, that means that you’ll occasionally set aside a bit less in some periods. It might only be a few cents or a few dollars, but it’s still worth the effort to assign it instead to debt repayment or savings, depending on what stage you’re at in your financial life. I’ve bother doing this for amounts as low as $0.95!
The result will be that the tiny balance will become 0.00 in the row showing when the payment gets transferred to your chequing account. You might detect a pattern and insert tweaks to the amount to be saved every Xth period to force a category’s counter to go down to 0.00 more frequently, as there’s no point in having a surplus locked into a category column when it would serve you better to pay off debt or in savings.
Of course, it’s a sad fact that prices tend to change — mostly upwards but occasionally downwards. Fortunately, they tend to change one at a time rather than all at once. You’ll need to update that category from the time of the price change (the amount due starting from the date of the increase onwards) and the amount to set aside going forward (per Table 2 below). This would be a good opportunity to reset the column’s counter to zero from the point of the increase. However, what you’ll find interesting is that even a substantial increase won’t seem so bad. In the span of a year when I went from owning an old car to a new car, the insurance on it went up several hundred dollars a year but this increase translated to only $14 per paycheque, which demonstrates very well the “shock absorbance” qualities of the yearly approach to budgeting.
After you will have repeated this exercise for each column set, the “Bal.” cell at the intersection of the “Account” column on the “RESET TO ZERO” row may show an amount that is greater than the amount of cash you have on hand. But that’s okay. Part of your debt consolidation plan might mean that you’ll have to increase your debt sligthly by borrowing from a line of credit or, if you must, a credit card cash advance, just to bring each of your “must pay” columns where they should be at this point.
Table 2–The Fixed Amounts Per Category
My fixed reserve categories are as follows, but yours could obviously be different (for example, if you have a student loan or a car payment). Notice how 2 times what’s in the period column doesn’t add up to the amount in the month column? That’s why I’ve been saying all along that taking a monthly view doesn’t work! If you get paid 26 times a year as I do, you’ll have to save a bit less each paycheque than the monthly amount divided by 2. THIS is how you get to see the effect of your two “extra” paycheques!
|Description||Amount||Time / Yr||$ / Yr||$ / Month||$/Period|
|Permit & Registration||345.06||1||345.06||28.76||13.27|
|Technology||Cable & Internet||130.97||12||1,571.64||130.97||60.45|
|Web Hosting||45.00 *||12||740.00||61.97 *||28.46|
|¤ Often a bit less than that, requiring occasionally adjustments to reset to 0.00.
* A service certificate for about $200 CAD is renewed once a year but the monthly fee is about $45/month the rest of the year. Amounts vary a bit due to the CAD/USD exchange rate, requiring occasionally adjustments to reset to 0.00.
** It’s really 8.77 over several years but I use 9 as the denominator and occasionally make adjustments to reset to 0.00.
I don’t know about you, but I find it very interesting that the amount I have to save each paycheque ($720.91) is considerably less (and less painful!) that my biggest expense each month (apartment and garage rents, $1,020.00). Plus I love no longer being among those who say, “Oh, well a huge chunk of this paycheque is going to get eaten up by rent.”
Note that my food allowance is not here because it’s part of the $400 per paycheque “allowance” I give myself that also includes my housecleaner and …uhmmm …yeah, smokes, all of which I’ll explain in next part of this series.