Why We Approach Financial Planning and Budgeting Differently

Picture of Jesse Mecham, founder and CEO of YNAB.
Jesse Mecham, founder of online budgeting tool “You Need a Budget.”

Disclaimer: Neither the author, nor Providers & Families Wealth Management, LLC or its employees, are affiliated with, compensated, or endorsed by You Need A Budget (“YNAB.”) This is not an endorsement of YNAB and should not be read as such.

On his company’s website, Jesse Mecham (founder and CEO of online budgeting tool “You Need a Budget,” or YNAB for short) explains in his like-titled book how budgeting and financial planning are different:

If it is impossible to perfectly predict your expenses, a budget needs to be nimble and adaptable, right? Except most budgeting systems are decidedly “set it and forget it.” You make a budget at the beginning of the month, set it in stone, valiantly try to bend the fates and laws of the universe to make the month turn out exactly like the numbers you guessed, er, projected. Oh, and then beat yourself up and feel guilty when it doesn’t.

In retirement planning, “forecasting” is very useful. We forecast what we will spend, how much things will cost, and how much more expensive they’ll get over time. We even forecast how are investments will perform, even though there’s no guarantees.

Related: Yes, You Can Keep a Budget

When it comes to budgeting, forecasting is much different. If we forecast what we’ll have, we’ll forecast how we can spend it, and often make the mistake of spending it now. This is why YNAB’s approach to budgeting is so unique: you only focus on what’s in your bank account today, and you split it up into bitesize pieces designed to accomplish its own tasks.

Budgeting is a fluid, active process that requires dilligence and awareness.

Most budgets are backward. You start by projecting or guessing what your income will be, then plan how to spend that money. The farther out you go with this exercise, though, the less accurate your guesses–about your income or your expenses–are going to be. (Go ahead, I dare you to try and perfectly predict your expenses even for a week). The result? You are always in the dark, guessing, and waiting for the other shoe to drop.

With YNAB, you only budget money you have right now. It’s an allocation system, rather than a forecasting system. Therefore, you are on solid ground, fully aware of what you have and where you are going.

What about that big bill next month? Slow down, we aren’t there yet. With YNAB’S approach, we focus on what are current money is doing. And if it our current money isn’t helping us achieve our objectives, then we need to rework it.

Check out YNAB for yourself here.

About the Author

Scot Whiskeyman is Founder and Partner of Providers & Families Wealth Management, LLC., and is a CERTIFIED FINANCIAL PLANNERTM . His primary focus is on retirement planning for established professionals and estate planning for seniors. He can be reached by e-mail at scot@providersandfamilies.com.

Accomplishing Your Financial Goals by Weighing Each Part

A man walks into his doctor’s office for his annual checkup. After checking his heart beat, taking his blood pressure readings, and flipping through his chart, the doctor breaks bad news to the man: that he’s got to lose some weight, or suffer some serious health consequences very soon. The man, very annoyed, explains to his doctor that he has tried to lose weight, but “nothing works.” He eats a salad for lunch every day. He cut out soda and beer. He has vegetables with every meal. It’s just genetics!

Not so fast. Further prompting from his doctor reveals the problem: the man dumps croutons, breaded chicken, and ranch dressing on his salads, making them no better than a fast food sandwich – and he does this daily. The vegetables he eats are always accompanied by high calorie dips. And his daily snacks of ice cream and M&Ms add nearly 1500 calories to his daily intake. Turns out they’re more than just a treat – they make up half his diet.

For anyone who cares about their health, filling in the blanks is easy: calories in > calories out. For this man, it’s confusing. He eats vegetables and some sweets, so what?

A good habit does not cancel out a bad one. When it comes to accomplishing one’s goals, the summation of all of his actions are what results in the consequences, whether desired or not. It’s not the lettuce that’s the problem, it’s the deep fried chicken and carb loaded extras on it.

The same is true when it comes to money. It’s not saving money that’s the problem, it’s avoiding wasting it. Would lower interest on my credit card help? Sure, but if I keep swiping it to buy useless junk, how much will my balance decrease?

Successful people look at how their individual financial habits impact their financial situation as a whole. By addressing their financial situation in parts, they feel more empowered to make real changes for the better.

Consider your financial situation and it’s parts. What can you cut out of the budget, however tiny? How much extra change can you throw into savings, or at your credit card balance?

Whether it’s improving cash flow, saving for a vacation, or paying off a credit card, big change happens when the weight of each part is tackled bit by bit. Cutting out croutons from a salad can reduce it by hundreds of calories. Give it time, and the impact of cutting out croutons will speak for itself. The same is true for your bottom line.

There is No Free Pet

Meet Sam: Pictured in “Innocence” Mode, Above.

One thing to know about my girlfriend’s family is that they are being fans of dessert. It’s not uncommon for her father to return from State College with 6 gallons of ice cream from the Berkey Creamery. One night after having dinner with her parents, the dessert of choice wasn’t ice cream, but rather homemade chocolate chip cookies – with extra cocoa. Great for people (at least, not lethal.) Not so much for cats.

Nevertheless, my cat Sam decided he would taste them while were away from home at the office. Always hungry and never discreet about his hunting, we returned home in the evening to find remains and crumbs of cookies, as well as the plastic bag that housed them, scattered across the kitchen floor and even into the living room.

Amazingly, he was fine. Considering how toxic dark chocolate is to cats, I thought we’d gotten lucky. Wrong.

A day and a half after his cookie binge, Sam threw up his regular diet (of actual cat food) onto a carpet on our basement. Things progressively got worse over the next several days. Normally a proverbial quadrupedal vacuum, he now barely ate. And what little he did it was thrown up immediately. It got to the point where he would walk right by his bowl, sniff his food, and not even take a bite. We knew something was still wrong.

There wasn’t much choice but to take him to the emergency vet to get checked out. An x-ray revealed that he was “backed up” – none of the food he was eating had anywhere to go, if you catch my drift. Enter the resolution – an enema. I’ll spare you the details, but suffice it to say we were fortunate that we didn’t spend more. Still, a 2 hour visit still set us back $400. Ouch, I thought. But it I’d deal with it.

Fast forward a few days, Sam had once again lost interest in food. So it was back to the vet – this time, the local one.  We dropped him off in the morning, only to find out in on an afternoon phone call with the vet that he needed some very expensive tests – which would set us back another $1500-$2000 dollars.

Just for context: We weren’t in a position to pay that kind of money. We had just gone through several months of expensive bills from Kalie – Lindsey’s 14 year old cat. Her frequent visits included dental surgery, and inspection of an abnormal spot on her backside. That spot become a lump. Ultimately, Kalie had to be put to sleep due to terminal cancer.

But back to Sam – the vet suggested keeping him overnight, instead of running the tests, which she admitted were costly. “I just keep going back to the dark chocolate he got into,” she said. She thought that if they kept him hydrated, he might be more willing to eat in the morning. And that’s what happened. He’s been fine ever since, and we’ve taken some preventative measures (elastic bands to keep his prying paws out of the cupboards, for example.)

The irony of having been gifted Sam as a pet isn’t lost on me. He was free! If you’re a pet owner, you know how much pets can cost. It’s a matter of when they’ll need to be treated by the vet.

Fully recovered & lounging on a soon to be installed dishwasher.

Need a good reason to have an emergency fund? Here it is.

The total cost of vet bills to get Sam health again was just over $1,400. Take it from me: it’s important to think of the cost of ownership in advance of taking on the responsibility of a pet. When it comes to animals, the emergency health issues they have are often completely unpredictable. Having cash on hand in the form of an emergency fund can literally be the difference between life and death for your pet.

Despite cash on hand being tight at the time, we managed to get Sam’s bills covered, and he’s home as happy and healthy as ever. He might be a member of the family, but we make sure he doesn’t get dessert anymore.

Should Employers Offer Payroll-Deducted Emergency Funds?

To keep your head above water, keep an emergency cash reserve stocked away (but still in arm’s reach.)

It happens more often that I’ve been able to count: a client leaves a job, and treats their 401k as a cash windfall. They have a reason, and they’ve convinced themselves that it’s a good reason, to rob themselves.

Here is a non-exhaustive list of permission slips savers have written themselves:

  • I need it to pay off debt.
  • We needed some things for the house/kids/yard.
  • My car needed a new engine.
  • It’s just what we needed to do right now.
  • We used it as a down-payment on a house.

The use of retirement funds for non-retirement reasons has become something of an epidemic. People use money intended to take of their future-selves, and, as one individual I met with eloquently put it, “bs” themselves into using it now – in other words, they rationalize an irrational decision. As a result, not only do the pay the IRS a tax penalty, but they pay income tax and rob themselves of compounding interest.

Is this an epidemic that can be controlled by better educating savers on the importance of saving for the future, or is it a symptom of a much larger problem?

In my opinion, it’s the latter. Rather than saving, we have developed a collective mentality of “spend now, pay later.” We spend every last dime of our paycheck, or worse, borrow from ourselves by using credit cards to make ends meet (and more commonly, live above our means.)

Is it any wonder that money once handcuffed is immediately used when it’s set free? After all, it’ll take some pain away…right now. There will be years and years to make up for it.

Here’s the problem: the making up for it never happens. The contract they entered into with themselves containing the open-ended, ambiguous  “someday” clause practically guarantees this. Without clearly defining exactly what day that is and what they are going to sacrifice to make up for it, they’ve effectively only treated the symptom (debt, lack of cash reserve) while the problem (bad habits) remains intact. And the side effect is that they’ve robbed their future selves.

What can we do to stop the epidemic? A new benefit: an Individual Emergency Account (IEA.)

Here’s the rationale: when a financial planner works with a client, one of the first things they should find out is whether or not the client has an emergency fund, or is building one. Without the proper cash cushion, the advisor knows that the plan can collapse very quickly.

Employee benefits packages often include other sound risk-management packages – life insurance, disability insurance, and accidental death and dismemberment policies, just to name a few. But little attention is paid to what the employees are doing to put away for their proverbial “rainy day.” Add to that the 401ks offers hardship – and sometimes, even loan – provisions – it becomes more and more obvious why employees treat their 401k like a bank account.

If we truly want to solve this problem, we should encourage a savings strategy with the sole purpose of covering hardships. What would this plan look like? It’s not exhaustive, but here are a few ideas.

  • Investment Options: an emergency fund is not something to gamble with. At least half – if not most – of the account should be put into an FDIC insured account, not subject to principle risk. Any remaining amount of money should into something low-risk, and very easy to turn into cash – at the employee’s option, of course.
  • Account Maximum: the account should have a roof of 3-6 months of whatever the employee’s salary is. Of course, if they are commission based, the maximum could perhaps be set at the average income of a first year employee. Once the maximum is reached, the employee could be rewarded – perhaps the account could pay them, in a gift card. Perhaps they could be encouraged to maintain their balance but receiving quarterly gift cards each time it is maxed out.
  • Usage. The Individual Emergency Account would need to more broadly define what an emergency is to allow employees access to the funds. They could be required to submit proof of use of the funds to the custodian. Any amount extra that was borrowed could be paid back. The could be penalized if they don’t return it. The emergency would include things such as a car accident, injury, illness of the employee or their loved one, birth of a child, or major car repairs. What would definitely not be considered an emergency: paying off debt, or putting a down payment on a house – things that should be worked towards with good habits.
  • Matching. Employees could receive a small match to encourage them to save, such as 1-2%. Rather than having a long vesting schedule, they could perhaps have a very short 3-12 month vesting schedule, after which it can all be used for an emergency.

Will it ever happen? Maybe. It’s up to employers to ensure that their benefits packages meet the four r’s of employee benefits: recruit, retain, reward, and retire. With a company match and the right incentives, employers could encourage their employees to prepare for a crisis – and what’s more, pay them to prepare for it. The alternative: employees continue robbing themselves for the sake of there here and now.

No one works well under the pressure of fear. Having the right benefits in place means giving employees financial peace of mind, which then leads to better performance. It’s in an employer’s best interest to keep this in mind.

Have an idea for an Individual Emergency Account? Comment below!