We’ve established that Rule One (Give Every Dollar a Job) is necessary to raise your awareness and begin the process of aligning what you want your money to do, and what it actually does. As you close the gap between your values, and your money’s behavior, you’ll find the financial peace you seek.
Understanding Rule Two (Save For a Rainy Day), we want to look ahead to the future and make sure we separate those large, infrequent expenses, into manageable monthly chunks. An example: your annual life insurance premium is $720 so you set aside $60 each month ($720 / 12 months) in your ‘Life Insurance’ budget category. When the bill comes due, you pay it in full and that month feels no different than the rest.
Tying the Two Rules Together
Let’s set Rule Two aside for a moment, and not think about the large, infrequent expenses that have caused us so much grief in the past.
Just think about the present obligations. When you’re sitting there with all of your dollars given jobs, you become acutely aware of the fact that if you want to add more to one category, you need to take away from another. This is zero-based budgeting, and it’s something that the brightest minds in Congress can’t seem to grasp.
If you want to spend more eating out, you’ll need to spend less on clothes. If you want to increase your monthly contribution to a Roth IRA, you’ll need to spend less…somewhere.
But let’s assume (again, still ignoring future Rainy Day expenses) that everything’s working out really well and heck, you still have $300 left over after meeting all of your monthly obligations, and even some of your wants and frivolities (which are necessary and good).
$300 surplus, all current obligations met. Check.
Now you look to the future.
Nicholas Cage starred in a movie with a horrible ending. Now you’re wondering which movie that could possibly be, since Nicholas Cage is only in top-tier Hollywood films? It was called Next. The premise was that he could see a few minutes into the future, then do things in the present to alter the future events.
You have him next to you and he can see a few months into the future and sees that you’ll be completely stressed and really having to scramble to handle a tire blow-out that will happen on your way to work.
(The sly guy in the room will say that you should avoid the blowout, not avoid the financial crisis caused by the blowout, but hey, let’s not think too hard about this, okay? My metaphor stands!)
So you decide that something you can do in the present is to plan for that blowout. $50 per month is set in the ‘Car Repairs’ category. You don’t know exactly how much it will cost but, even without Mr. Cage’s fortune-teller skills, you do know your car will need repairs.
You do the same with Christmas — $200 per month I guess.
And your vacation. You decide that will cost $1,800 so you try to set aside $150 per month.
Your perfectly balanced budget had, after meeting your current obligations and wants, a $300 monthly surplus. With the car repairs, Christmas, and vacation all becoming monthly obligations, you’re now at a $100 deficit.
Present Self Negotiates with Future Self
And here’s where the magic of Rule One + Rule Two really happens.
You now get to decide if what you currently want, and what your future-self wants, can somehow coexist. Perhaps there’s some middle ground that can be met. Perhaps you’ll decide that $2,400 is far too much to spend on Christmas and you ratchet it down a bit (be realistic here!). Or maybe you decide you could pull of vacation for $1,500 instead of $1,800. That certainly helps…
And then again, maybe you look at your current obligations and decide that you really DO want an $1,800 vacation and you’re willing to give up some current obligations to get there: eating out here and there, going to a few more matinees, bringing lunch to work, etc.
The beauty comes from the fact that your present self is now able to make decisions now, knowing full-well that there are future goals being affected. Up to this point, you’ve just wondered why you haven’t been getting ahead financially–now you know.
The old you would have just done Christmas anyway — spending way too much and most of it on the card. The old you would have done the Vacation anyway — spending more than you would have if you’d budgeted for it (because you’re feeling guilty, so you’re actually spending to soften the blow). The old you would have seen the blown out tire as a serious financial crisis. You would have adopted a “woe is me” attitude and you wouldn’t have been any fun to be around for the next week.
This is the new you now. It’s future-you, and present-you, all mashed together to create the Financially Formative You. It should feel very good.