We have examined our Income for ways to optimize our current situation and start planning for future opportunities. We have also examined the differences between Expenses and Living, as well as how to make the spending in these areas align with our goals and values. This has led us to forgo the traditional budget in favour of tracking our spending and in turn forecasting our spending. Now we will address where Buffer and Savings come into play.
At the start of every month I take my Income from the prior month and like YNAB’s Rule #1 Give Every Dollar a Job. This is a forecast of my anticipated spending. The longer you follow the methodology of tracking your spending, and reviewing monthly, the more realistic your forecasting will be. I also set savings goals by categories, such as TFSA contributions, RRSP contributions, and Mortgage Principle Reduction.
At this point some definitions might help:
- TFSA = Tax Free Savings Account
- RRSP = Registered Retirement Savings Plan
- Mortgage Principle Reduction = Directly reducing outstanding mortgage balance in addition to regularly scheduled payments
Note: Despite the sound of it both TFSA and RRSP accounts can, and should, hold investments and not just cash.
Then I allocate all remaining Income into my Buffer. Here are some specific examples of what the Buffer is used for: 1) funding monthly spending that exceeds my forecasting; 2) covering the cost of handling any emergencies that might arise; and 3) a place to capture savings that exceed our monthly targets.
There are two ways I manage forecasting: pre-saving and monthly budgeting. For bills like Hydro, Gas and Water, I estimate my average monthly costs and pre-save. Every month I allocate $70.00 to Hydro regardless of the bill amount, in the winter my payments are less than this, but in the summer my payments are more than this, and in the end it all evens out. On the other hand my Groceries category is budgeted for monthly, and though there are fluctuations from month-to-month I am able to adjust my spending choices monthly to keep it from growing out of control.
At the end of each month I review my actual spending against the forecast. For pre-saving categories I only make sure that the actual never exceeds the total available. If it does the amount being saved monthly needs to be increased to ensure there is enough money to cover these expenses. For all other categories the forecast is adjusted to reflect the real spending. This process will either leave you with more money needing to be assigned a job, or a shortfall that needs to be covered. An excess is added to the Buffer, and a shortfall is funded from the Buffer.
Now it is time to follow YMOYL’s process for examining your monthly spending by category. Remember that this process will help you maximize your enjoyment while controlling or reducing your spending. During this monthly review I look at my Buffer balance. When the balance is greater than the money I would reasonably need for an emergency I direct the excess funds into one of my Savings goals as a one-off contribution. Since buying my house five years ago this “extra” money has been reallocated to paying down the mortgage faster.
I should make a few confessions before you get the wrong impression. First of all it isn’t “my house”, or so my Wife likes to remind me, it is “our house”. And the same goes for our finances. We have our own chequing (or checking for our American Friends) accounts, and our own high interest savings accounts. We do have a joint account for our mortgage payments, but for planning and functional purposes our finances are 100% combined. This approach doesn’t work for everyone, but it does work nicely for us. Second, though my Wife believes in tracking and categorizing spending she doesn’t see the value in getting every penny captured. She has no problem with me doing all of the tracking, since I am the one who wants to be precise and complete (yeah, I might have financial OCD). Each month we jointly review our spending and make adjustments together.
At the start of every year my Wife and I sit down and review our finances and set goals for the year. We take our average monthly Income and subtract our average monthly Expense and Living amounts. This leaves us with a ball park of what “Gap” we will have for the coming year. Together we work out what our Saving priorities will be for the year, these fall into two categories: Real Savings and Saving for Large Expenses.
Real Savings for us are TFSA contributions, RRSP contributions and Mortgage Principal Repayments. Each year we identify how much we want to go to TFSA and RRSP, and how much priority we are putting on paying down our mortgage faster. Then we pick one or two large ticket items to save up for. For instance we like to travel so we set aside money each month for a vacation where we fly out of the country. Or something like a renovation or a new car that we will save up monthly for and only buy when we can pay for it in full. We make these savings goals reasonable, meaning we don’t make our total savings goals for the year equal the full anticipated Gap amount. Because life happens we need to have financial room to adjust, and that is where our Buffer comes in.
This annual planning session is, for us, probably the most important phase. It makes every monthly forecast quick and easy because we have a master plan. If things change during the year we discuss if our priorities for the year have changed, or if the excess from our Buffer category will solve the issue. Three years into using YNAB and our monthly meetings take between ten and twenty minutes.
During the month you will be capturing all financial transactions that flow into and out of your life. As the month progresses YNAB shows you your actual spending against your forecasted spending. This allows you to make informed purchasing decisions before they are made instead of weeks later at your monthly review session. It is this aspect of YNAB that helps people gain total control over their personal finances. Controlling your spending real time is a major cornerstone to a healthy financial outlook.