The Concept That Changed Our Financial Life

by Kevin on March 11, 2008

Update #2: I posted a follow up on this article for a reader question. That article included more images to help everyone understand what is going on.

Update: Hello, Reddit!

If there is nothing else I can share with you on this blog, let it be this: keep a one month income buffer. This has been the key to our budgeting success. (We are no longer living paycheck to paycheck thanks to this system!) This concept is so important, I fear I will explain it incorrectly. Please don’t hesitate to comment with questions or concerns. Again, I honestly think this is the most important thing I can offer to you.

Here’s how it works: don’t spend the money you earn this month. You are going to spend it next month based on your monthly budget. That means you should be living this month on last month’s income. It sounds confusing, but it really isn’t. I think it is a simple system if you can get your head around it. How about an example?

A Simple Example

You earn $3,000 after-tax every month. Your direct deposit is sent twice per month on the 14th and 28th. You have three expenses: rent ($800), food ($300), and utilities ($200). Rent is a fixed cost — it shouldn’t change until your lease runs out. Food and utilities are variable — they change each month. Some months you eat out more, some you cook more. Some months of the year it is cold and you use the heat more, other you are using very little heat. On average, your expenses total $1,300. This leaves you $1,700 to do with as you please, preferably savings.

Now your typical person will take the money they receive on the 30th of the previous month to pay the next two weeks worth of expenses. Then when the check comes in on the 15th, it pays for the next two weeks of expenses. If you used 100% of the money every two weeks, you wouldn’t have any savings. Doing this is called living paycheck to paycheck. That is, if your paycheck doesn’t arrive in two weeks, you can’t pay your expenses. Bad news.

What We Do

We take all of the money in month one, say March, and leave it in our checking account. It’s in the account, but we don’t touch it. Every time we get paid in March, we simply put the money aside and hold onto it. At the end of the month our budgeted amounts for food, utilities, and the like should be pretty low. That’s okay, it’s the end of the month. Hopefully we aren’t in the red, either (for the budgeted categories, not for our checking account in general). Remember, we’ve got all of March’s earnings sitting in the account waiting to be utilized for April.

Using the above example, this is how it might look:

  • March 1: Just getting started
    • Total in checking: $1,300 ($1,300 budgeted for March, $0 earnings from March)
  • March 8: Buy groceries for $50, pay electric bill of $100.
    • Total in checking: $1,150 ($1,150 left for March, $0 in paychecks from March)
  • March 14: Get paid $1,500; buy groceries for $50
    • Total in checking: $2,600 ($1,100 left for March, $1,500 in paychecks from March)
  • March 16: Pay gas utility bill $100
    • Total in checking: $2,500 ($1,000 left for March, $1,500 in paychecks from March)
  • March 21: Pay rent $800, buy groceries $100
    • Total in checking: $1,600 ($100 left for March, $1,500 in paychecks from March)
    • At this point we are getting pretty low on our budgeted money for March. Hopefully we don’t have too much more expense to incur as we don’t want to dip into our paycheck money if we can keep from it.
  • March 28: Get paid $1,500, buy groceries $100
    • Total in checking: $3,000 ($0 left for March, $3,000 in paychecks from March)
  • March 31: We don’t spend any more money this month. We now re-allocate our paycheck money for April’s expenses.
    • Total in checking: $3,000 ($0 left for March, $1,300 budgeted for April, $1,700 left from paychecks in March that should be moved to savings)

Note that every time you spend money in March, it doesn’t affect the money you’ve earned in March. It only affects what you’ve budgeted for March.

Now rinse and repeat for April. Save your paychecks in April, and live off of your $1,300 budgeted for the month. Any excess at the end of the month (hopefully near $1,700 or so) goes towards savings.

I hope all of that made sense. Essentially, you are setting aside your budget at the beginning of the month and only using that money for that month. The money you earn during the month goes towards next month.

Above all other things, this concept has helped us move towards financial freedom.

It Takes Time

I’m not saying it is easy to get to this point. If you are currently living paycheck to paycheck you may not have a lot of wiggle room. If your monthly expenses are $1,300 and you only have $25 left to your name at the end of every two weeks ($50/month), you have an uphill battle to climb. If you don’t make any other changes to your life, it is going to take you 26 months to save up a one month buffer. Even if it took you that long, it’s worth it. You might consider cutting your expenses or increasing your income to speed up your process. Of course, if you had $1,700 left at the end of every month then you can try this next month.

Flexibility

Living on last month’s income gives you some flexibility in your finances. If you spend $350 on groceries this month (versus a budgeted $300), your checking account doesn’t go into the red. If your utilities bill were slightly higher than expected, you aren’t having to choose which one to pay first. That overage can be covered by your excess money, and perhaps you adjust your budget for the next month.

Again, there has been nothing, nothing, more crucial to our success in managing our finances than this concept.

Stop living paycheck to paycheck. Stop trying to time when you pay your bills. Live off last month’s income this month. Try it one month, and I think you’ll be convinced. We absolutely love it.

* * *

To answer a question from a comment on how I came up with the numbers — I made them up.

“Why didn’t you include a car payment, or this, or that?” It makes the example extremely complicated very quickly. Having a handful of expenses simplifies things. I do understand that you probably have 10-20 different expenses you need to track.

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{ 26 comments… read them below or add one }

Future Millionaire March 11, 2008 at 7:49 am

Thanks for sharing Kevin. I do a very similar savings/budgeting plan as well and live off of last month’s income. I put my paychecks in my money market and then at the end of each month transfer what I need to pay bills for the next month into my checking.

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Fiscal Musings March 11, 2008 at 8:49 am

I can see how this system would work for you. I prefer to avoid only saving what’s left over after the month is over and make the savings and investment transfers first when the money comes in. Bills and other expenses are then paid with what is left over. I just like to put the savings and investment priorities first.

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Mom March 11, 2008 at 10:59 am

This is EXACTLY how we budget too. I seriously thought I was the only one. Whenever I try to explain our system to someone I get strange looks.
I started using this system when I moved out on my own as a kid and I can’t imagine doing it any other way.

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kentuckyliz March 19, 2008 at 5:08 pm

Too complicated for me. I just leave several hundred extra dollars in my checking account as a buffer, and have an emergency fund.

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Milwaukee Web Design March 25, 2008 at 7:59 am

You want me to stop spending my paycheck for two weeks? That’s two weeks without food. I’m sorry, but for some of us, it’s necessary to spend our paychecks, in order to live.
-Just another grossly underpaid american

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Webomatica March 25, 2008 at 10:09 am

Personally I prefer the urgency of a “pretend bill” meaning savings is mandatory in the form of a monthly automatic withdraw. This can be as small as $50 a month if need be. I find if this happens regularly – just like a bill for utilities – it is psychologically easier to “come up” with the money for it. We’ve been doing this for several years and that automatic withdraw amount has increased substantially.

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bshock March 25, 2008 at 10:11 am

My initial reaction to this was, “Where does this guy think we live — Muncie, Indiana?” Which isn’t a realistic question, because I doubt if most people clear $3k/month after taxes in the midwest U.S. But I can’t imagine how you got those expenses otherwise. That “utilities” bill is especially crazy — I pay at least twice that in Phoenix, AZ.

My next question was about why there were so few expenses. Where’s your student loan payment? Where’s your car payment? Where are your incidentals, like gasoline, clothing, and medical co-pays? Where’s your alimony? Where is the bill for the credit card that your insane bitch of an ex-wife charged up before she trashed your apartment and ran off with her girlfriend?

Finally, while I have to congratulate you on a simple, logical financial plan like this, I have to say that I’ve met only two or three people in my life who can actually stick to a simple, logical financial plan. It’s not that there’s anything wrong with the plan — rather, it’s that life gets in your way. Your car breaks down, you need root canal work that’s not handled by your company’s dental plan (please, find me an affordable dental plan that handles root canal and caps!), you lose your job and blow your reserves on survival, the market tanks and takes your 401K with it, gasoline goes up to $4/gallon and keeps rising…

I guess if I were a smart, motivated, well-disciplined 18-year-old, I might be able to follow your plan. Congratulations to all smart, motivated, well-disciplined 18-year-olds… all 4 of you.

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chris March 25, 2008 at 12:23 pm

can that be done in the US?
Is it legal to just spend money you own?
Doesn’t this have a negative impact on the financial system?
Debts are essential for financing the the US economy… my interests are need by banks.
how would bear stearns be without interests??

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Bahamut March 25, 2008 at 12:47 pm

$3,000 after-tax a month is rich. Taxes by itself take about 25% of your paycheck. So you’re saying you make gross $4k a month? What about contributing to your 401k? If you use public transportation, there are usually company programs to take the cost before taxes from your paycheck. Company health insurance? Add this in, you’re saying we should be making about $4,500/$5,000 a month? Yeah, maybe you should use some more realistic numbers.

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Vince P. March 25, 2008 at 2:17 pm

To all the naysayers who say this can’t be done because they don’t make as much money as he does: His example is not your example. And his example is simple, on purpose. If you don’t do this, or some variation of it, then you will not have any money to use as a buffer. If you’ve ever had to choose between buying food or fixing your car, etc. you should be able to appreciate having some rainy day money saved up. That’s all he’s really saying. You can call it “live on last month’s paychecks”, or whatever you like, but don’t use word games to dispute his basic point. Virtually no one in this country has good excuses to NOT do this; even if you live on minimum wage. If you smoke, drink, go to movies, eat out, buy electronics/computer games, etc. then you have enough money to do this in some small way at the very least.

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FUSe March 25, 2008 at 2:52 pm

So basically…you are saying that one should not spend more than they make and not buy things that they don’t need, even if they can afford it.

WOW YOU ARE ONE OF THE SMARTEST PEOPLE IN AMERICA!!!
And sadly, that statement is true…

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Karen March 25, 2008 at 5:53 pm

bshock…take you snarky attitude about the midwest and shove off. There are plenty of smart, hard-working, well-compensated people living in flyover country, even Indiana. I’m one of them. And, Bahamut, taking a couple of months off your 401k to build an emergency fund is not going to destroy your retirement.

As for the OP…my spouse and I did something similar when we were in our mid-twenties, and lo and behold, we even had student loans. Kevin, you’ve given great advice. Two thumbs up!

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Renee May 17, 2008 at 9:51 pm

I did this by waiting until I had an income tax refund check that was equal to one month’s salary. I deposited that check on the first and then held each week’s check and deposited the total amount the first of the next month. I didn’t know other people did this, either. My extended family thinks I’m crazy.

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Lloyd May 23, 2008 at 2:42 am

hi there, your suggestions are very helpful. Was wondering if you have any good informative ebooks on the subject. Do let me know…thanks in advance…cheers:)

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Cheap Trick January 6, 2009 at 1:14 pm

I do a modified version of this that might be a bit easier to execute.

First, do a rough budget to get a total cost per month, add 10% to that and divide that by 2. If this amount is more than your paycheck, see where you can squeeze even a few bucks a month under this amount ($5 is fine). Commit on your pay day that you will transfer to your checking account only the amount you’ve calculated. This gets easier f your company offers direct deposit, as you can have deposits go to your savings account or make a habit of depositing your check to your savings account first.

At that point, just proceed to use the money in your checking for bills, and the 10% is for you to use as needed, but if not used, rolls over for use at the next pay cycle. Once you’ve grown your rollover enough to pay an equal amount of a bill, pay that bill a month early and continue to pay as normal, and then pay a different bill a month early the next time you have the spare change. At some point you will end up with all of your bills being a month ahead, and there you have yourself living a month ahead. If you hit a hard time, use the spare cash in checking as needed and then work the plan over again to get back to being a month ahead. If your really in to this, I made myself over about 4-5 years time get about 3 months ahead on my bills.

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matt May 4, 2009 at 2:43 pm

renee you do this too?….kevin this is a great article…….its easier to budget monthly than by pay periods…

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matt May 17, 2009 at 9:42 pm

renee you still do this?

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Nancy January 30, 2010 at 7:27 pm

I get it! I had to read it a few times but I understand and it makes more than perfect sense. Last year, my husbands pay schedule switched from getting paid on the 15th and the 30th to getting paid every other week. We spent all year trying to catch up because each check was several hundred dollars less on this schedule. Of course, twice a year we got “extra” checks, but by then we were still playing catch up. Had we been living off the previous month’s income instead of the current paycheck, the impact would not have been nearly as great. Now that we are working hard to get debt free and build an emergency fund, I see how living on the previous month’s income is imperative to reaching our other financial goals. THANK YOU!!!!!

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Renee February 16, 2010 at 7:38 pm

After reading your debt reduction plan I am a bit confused when you say:
We take all of the money in month one, say March, and leave it in our checking account. It’s in the account, but we don’t touch it. Every time we get paid in March, we simply put the money aside and hold onto.

so, don’t you pay your rent and bills (light, gas rent) due for March. I am just starting out, how can your system work for me.

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Bab March 7, 2010 at 7:15 am

Hi, when my husband and I started dating 100+ years ago…. I was the financial expert and he had a great job and zero interest or experience in money management. Within 3 months of our meeting, I took over his checkbook, facilitated his opening and contributing to his IRA and have managed our resources to an excellent net worth ever since!

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harris October 25, 2010 at 2:10 pm

I think people are making this too complicated. From what I understand, just keep one months expenses in your checking account. Then, you are using your paychecks each month as working capital. If your expenses are $2500 and you get paid $3000 per month post tax, keep $2500 in your account and at the end of the month, you should have an extra $500, making the grand total in your account $3000. Do with that extra $500 as you wish. It’s essentially surplus.The balance should never be below $2500 though. This keeps you from worrying about your balance being too low at the end of the month.

I think the thing that is confusing people is the accumulation of that 1st month’s money without paying bills. You pay your bills but you are going to have to save each month until you hit that amount that you bills are equal to, then the process can start.

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Striving for Abundance November 23, 2010 at 7:33 am

I like this tip. Just recently I started taking my finances seriously (rather than them taking me) and have decided to do something similar. I’m not at the 1 month buffer yet (more like one week), but it does offer a sense of security.

Your blog is an inspiration.

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Brandy June 27, 2011 at 11:20 pm

I love your concept and I defintely will do this plus i have a reception and my son party to plan so maybe this will work for that.

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France Collections September 3, 2011 at 3:10 pm

Good concept, I will try tis system next month and I’ll post results after.

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Katie April 18, 2013 at 8:57 am

Seriously? Where the heck are you living, and what job are you doing, that clears you 3000 a month? I am living off of 1300 a month, and live VERY frugally and I budget everything to a T. How you are able to go a month without spending anything is beyond me-if I did that I’d be so far behind on bills I’d NEVER catch up. This is unrealistic.

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Anna August 22, 2013 at 5:11 pm

Are you dreaming? What decade are you living in? Since you lump everything under utilities I’m listing all monthly bills leaving out health insurance, co-pays, property taxes, roadside assistance, etc. to “keep it simple”.

Try $500-600 level billing for electricity and gas, an optimistic $75 for water and trash, $125 for auto gas, another $100 car insurance, $75-175 homeowner’s or renter’s insurance, $60-80 for cellphone, and then the luxuries cable/Internet $75-180.

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