The wonderful thing about calculating your Hard Limit is that you now know how much Spending Money you can blow to zero each month without worrying that there isn’t enough to pay your bills, hit your savings goals or prepare for spikes in spending in the future. Woo-hoo!
In theory you have answered the nagging question “What can I afford?” But you still have to go one step further in order to ensure that the plan is easy to maintain and that it’s easy to figure out if you can or can’t afford something in the moment when you are about to spend money.
Here’s the trick: each pay period, you need to isolate your Spending Money in a separate bank account. That way you never have to worry about whether or not you’re spending money earmarked for bills and savings. When all your money flows into one bank account, bill payments, savings and Spending Money blend together; there is no strategy and no obvious indicator of affordability. It perpetuates the Spending Vortex.
For example, when all your money is in one bank account and you know the mortgage payment will come out tomorrow morning, it’s tempting to put most other variable expenses today (such as groceries or gas) on a credit card, just in case. But when you isolate the money you are allowed to blow to zero in a separate bank account, there is no need to worry about whether or not the mortgage will be covered or what you can afford to spend. You can see the balance as plain as day in the Spending account. This gives you a clear yes or no answer to “Can I afford this?”
Can I afford to go out for dinner tonight? Is there enough in the Spending account? Yes? Great. Can I afford to buy this coat? Is there enough in the Spending account? No? I’ll wait until the next paycheque.
It’s that simple.
Your Strategic Banking Plan
Here’s how to set up your strategic banking plan.
Step 1: Isolate the money you cannot spend in your original chequing account
In order to do this, you need to have two chequing accounts. Your original chequing account is likely where your money from work is deposited every month and where your Fixed Expenses are paid from. This is where you’ll keep the money you cannot spend each month to cover Fixed Expenses, Meaningful Savings and Short-Term Savings.
Rename this bank account “Bills and Savings.” If you have combined finances with a partner, this could be a joint account.
In our example, your Fixed Expenses are $1,450, your Meaningful Savings $416 and your Short-Term Savings $250. The total amount of money you cannot spend each month is $2,116 ($1,450 + $416 + $250). This is the monthly amount that you need to set aside in your Bills and Savings account.
You should consider the money in the Bills and Savings account dead to you. Never touch it. None of it is Spending Money. Every dollar that stays in that account has a very specific job to do—even if it doesn’t do that job for months at a time, in the case of annual Fixed Expenses.
Step 2: Isolate the money you can spend in a second chequing account
You’ll need to open a second chequing account. As with the Bills and Savings account discussed above, if you’ve combined finances with a partner, this could be a second joint chequing account. Ensure that this is your primary chequing account. That means your debit card is affiliated with it, so when you withdraw money from an ATM or spend money at a store checkout, you are taking it from this account only. Name the account “Spending.” This account is where all your Spending Money goes—all your guilt-free money in one spot. Woot!
Watch out for bank fees. Ask your financial institution if there is a way for you to have multiple bank accounts for one set fee. If not, see if you can get the overall fees reduced. Often if you’ve got multiple products with one financial institution, such as a mortgage, savings accounts and credit cards, they may be willing to discount your fees.
If you can’t find free (or cheap) banking that will work for you, try to keep your monthly fees on this new plan below $15 to $20. It may seem counterintuitive for a financial expert to recommend multiple accounts that may cost you a bit more money each month, but the financial benefit of your strategic banking plan will outweigh the cost. Trust me. Think of it this way: Would you pay an extra $15 for an app that lets you never have to worry about affordability and money again? If the answer is yes, then the bank fees you may have to pay are likely worth it.
In our example, your monthly after-tax income is $3,000 and $2,116 of that is the amount that needs to be in your Bills and Savings account, which means $884 ($3,000 – $2,116) goes into your Spending account. This is your Spending Money, isolated in a bank account so that you know it’s all money you can blow to zero!
Step 3: Figure out what to put in your bank accounts per pay period
This third step is my favourite—it’s the key to really giving you control over your cash flow. You need to figure out how much money you can spend and blow to zero for every pay period in your Spending account. Knowing on a monthly basis just isn’t good enough. A month is a long time: lots of different expenses can come at you.
On payday it can feel like you have lots of money, but then the whole next paycheque has to go to rent or mortgage or daycare and you will feel like you are broke until the next payday. By isolating your Spending Money for each pay period, you put an end to the feast-or-famine spending habits that can happen when you “budget” on a monthly basis.
Arrange to have all your income deposited into your Bills and Savings account. Then, each pay period, simply move your Spending Money from the Bills and Savings account to your Spending account. In our example, your Spending Money is $884 per month, so you divide that amount by two because you get two paycheques a month. So, with each $1,500 paycheque, you’ll move $442 ($884/2) from your Bills and Savings account to your Spending account. This leaves $1,058 ($1,500 – $442) in the Bills and Savings account for that pay period to deal with the bills and savings that will be coming out of the account or to build up in there. Some people like to manually move their money each payday, while others like to automate the transfer. It’s totally up to you. So here’s what happens with each paycheque: $1,500 comes into Bills and Savings account, you move $442 to the Spending account, and that leaves $1,058 in Bills and Savings.
If all your bills come due at the beginning of the month, worry not. I will walk you through Jesse’s strategic banking plan to show you how to deal with that, later on in this chapter.
If you’re paid every other week, you get 26 paycheques a year. But as I’ve said before, for 10 months of the year you will only have two paycheques per month, so it’s safest to plan for two paycheques per month, and then the extra two paycheques can be earmarked for Short-Term Savings as they come in. It’s the same if you’re paid weekly. Plan for four pay periods a month, but know that four times a year you will get five paycheques in a month. Those additional four paycheques should go to Short-Term Savings. For each weekly paycheque in our example, you’ll move $221 ($884/4 weeks) to the Spending account.
If you’ve got additional paycheques to play with, here’s how they can help with your Short-Term Savings. Figure out in advance when those additional paycheques will come during the year, and mark the days on your calendar. Go to your calendar and look up your last payday. Then count out each payday for the next 12 months. There will be two months when you have three paydays if you’re paid biweekly, or four months when you have five paydays if you’re paid weekly. On the days of the additional paycheques, move your usual amount of money to the Spending account, but instead of leaving the rest in your Bills and Savings account, move it to Short-Term Savings (there’s more about setting this up in the next step).
For example, let’s say that March and August have three paycheques. The third paycheques come in on March 30 and August 31. On those specific dates, $1,500 will go into the Bills and Savings account as usual and you will move $442 to your Spending account, also as usual. However, the $1,058 left over will go to Short-Term Savings instead of remaining in the Bills and Savings account. Why? Because you’ve already put $1,058 from each of the first two paycheques that month into Bills and Savings. Your Fixed Expenses, Meaningful Savings and Spending Money needs are already covered for the month, so the extra $1,058 from that third paycheque can go straight to Short-Term Savings. This can help to offset how much you need to put towards your Short-Term Savings each year, or you can use it for those purchases that inevitably crop up beyond typical planning (Hello, best friend’s bachelorette party! Hello, soccer camp!). See the section “Extra Paycheques” in the Resource Library section for more details.
Self-Employed? No Worries
If you’re self-employed, it’s easiest to move money on a monthly basis. It’s good practice to have a totally separate bank account for your business income and expenses outside of your personal bank accounts, so there will be three accounts instead of the usual two. All the revenue you earn should go into your business bank account. Then, once a month, you will “pay” yourself a consistent after-tax income.
Think back to the example we discussed in the previous chapter. If your revenue was $60,000 a year, you ended up with $36,000 in after-tax income (after $10,000 in business expenses and estimated taxes and CPP of $14,000). That left you with a monthly after-tax income of $3,000.
Annual revenue |
$60,000 |
|
Annual expenses |
– $10,000 |
|
Annual before-tax income |
$50,000 |
|
Annual expected income tax |
– $14,000 |
(estimated with online calculator) |
Annual after-tax income |
$36,000 |
($50,000 – $14,000 income tax and CPP) |
Monthly after-tax income |
$3,000 |
($36,000/12 months) |
The $3,000 in monthly after-tax income will move as follows from your business account: $2,116 to your Bills and Savings account each month to cover your Fixed Expenses ($1,450), Meaningful Savings ($416) and Short-Term Savings ($250). You’ll also move $884 each month to your Spending account. By only moving what you need for your personal bills and savings and spending, you leave enough money in your business account for your forecasted business expenses ($10,000) and your income tax and CPP ($14,000) over the year.
No More Worrying about Affordability
By isolating the amount of money you can spend to zero in your Spending account each pay period, you don’t have to guess about affordability anymore. If it’s the day before payday and your Spending account has only $5 in it, you needn’t worry, because all of your bills and savings are taken care of. You’ve already done the hard work, so just eat soup or what’s in the freezer that night and wait for your next instalment of Spending Money on payday.
If you like to use a credit card, go ahead. I also love earning points, but be sure to transfer the money from your Spending account to that credit card every night (provided that the banking fees for transactions aren’t atrocious). That way the Spending account is always a true representation of the money you have available until the next paycheque. Why is this so, so important? One of the most common overspending blunders I see is using a credit card for every transaction with the intention of paying it off at the end of the month. But inevitably there isn’t enough money in the Spending account to pay it down to zero, so debt starts to creep up.
You see, unlike a chequing account, your credit card typically does not have a Hard Limit that is low enough to keep your spending in realistic check. This is exactly what makes handling money so stressful. You never really know if you can afford your life or not. If you pay off the credit card as you go, you still get all the benefits of using a credit card (convenience, points, etc.) but you also have that go-to place where you can see your Spending Money going down in real time. That way you always know where you stand financially until the next pay period.
Step 4: Automate everything in the Bills and Savings account
If you want to take all the guesswork out of your finances, get automated. Yes, this is the most overused and obvious financial tip in the world, but it still holds true. Just like advice to put on your underwear first, a good tip is a good tip.
If possible, every transaction that comes out of your Bills and Savings account should be automated. It’s a good idea to set the preauthorized payment dates that you have flexibility in choosing at the end of the month, so that your Bills and Savings account has time to accumulate the max amount of money.
When it comes to your Fixed Expenses, utilities may be tough to set as a preauthorized debit amount because they can fluctuate a bit. But otherwise, most of your Fixed Expenses should be so consistent that you can automate a specific amount with preauthorized debits. For utilities or other Fixed Expenses that fluctuate slightly, you’ll have to pay them manually from the Bills and Savings account each month, when they are due. But since you’ve put enough aside to accommodate the high and low fluctuations, you will have enough in the account to pay them.
As for Meaningful Savings, the amounts that you are sending to debt, retirement savings, TFSAs or your mortgage should also be preauthorized debit transactions. It’s a good idea to have your Short-Term Savings automatically transferred to a safe, liquid savings account. This is a great way to see what you can and can’t afford when it comes to spikes in your spending. For example, if you’ve got money specifically put aside for vacations in a separate short-term saving account, you can plan what type of vacation you can afford simply by looking at the balance.
“Can we afford to go to Chicago?”
“How much money is in the vacation account?”
“$1,200.”
“Yep, we can do Chicago on $1,200.”
Some people really get into this and like to have a bunch of short-term savings accounts, one for each goal. As long as the banking fees aren’t crazy, this can work.
My recommendation is to have two Short-Term Savings accounts: a “spikes” account and an emergency account. The first is for the predictable spikes in spending that you’re saving up for, things like vacations, Big Purchases and big events coming up, then a separate account for your emergency savings. It’s a personal decision. There’s no right or wrong way when it comes to stashing your Short-Term Savings. All that matters is making sure the money is automatically transferred out of Bills and Savings.
No more feast-or-famine paydays. No more moving money from account to account to cover payments. No more wondering if you can or can’t afford something. A system. It’s simple and hella effective.
Jesse’s Strategic Banking Plan
Here’s how I set up Jesse’s strategic banking plan. First, as a refresher, here’s how Jesse’s Hard Limit shook out:
Monthly after-tax income |
$3,750 |
FIXED EXPENSES: Money You Cannot Spend |
|
Rent |
$1,000 |
Phone |
$100 |
Subscriptions |
$10 |
Student loan minimum payment |
$65 |
Car payment |
$350 |
Car insurance |
$125 |
Total |
$1,650 |
MEANINGFUL SAVINGS: Money You Cannot Spend |
|
Retirement savings |
$500 |
Student loan above-minimum payment |
$60 |
Total |
$560 |
SHORT-TERM SAVINGS: Money You Cannot Spend |
|
Car repairs ($480/year) |
$40 |
Gifts ($300/year) |
$25 |
Total |
$65 |
SPENDING MONEY: Hard Limit |
$1,475 |
Step 1: The Bills and Savings account
We know that the money Jesse cannot spend stays in the Bills and Savings account and the money he can spend goes to the Spending account.
Monthly Amounts |
|
After-tax income |
$3,750 |
Bills and Savings account |
$2,275 |
Spending account |
$1,475 |
Jesse is paid twice a month; $1,875 drops into his chequing account on the 15th and 30th of each month. If Jesse’s Bills and Savings account needs $2,275 each month to cover his Fixed Expenses, Meaningful Savings and Short-Term Savings, then we divide that amount by the number of paycheques per month (two) in order to find out how much he needs to leave from each paycheque to ensure that everything is covered. So Jesse must leave $1,137.50 ($2,275/2) in the Bills and Savings account from each paycheque in order to ensure that he has at least $2,275 to meet his Fixed Expenses, Meaningful Savings and Short-Term Savings.
|
Monthly |
Per Paycheque |
After-tax income |
$3,750 |
$1,875.00 |
Money you cannot spend (Bills and Savings) |
$2,275 |
$1,137.50 |
Money you can spend (Spending Money) |
$1,475 |
$737.50 |
Easy, right? Wrong.
“When are your bills due, Jesse?” I asked.
“All my bills are due at the start of the month, hence the feast and famine.”
“Are there automated transactions in the Bills and Savings account that you could change the timing on?” I asked.
“I can adjust the withdrawal date for my retirement savings, the extra money to my student debt and the money going to Short-Term Savings. The other transactions have to come out on the date that is set on the bill,” he said.
“Okay, so let’s plan for all your savings, Meaningful and Short-Term, to come out at the end of the month,” I said. “Then we will map out the cash flow in your Bills and Savings account each month to see if there’s a shortfall.”
If Jesse gets paid on the 30th and puts $1,137.50 into Bills and Savings, he will end up short. This is because $1,550 ($1,000 rent + $10 subscription + $350 car payment + $65 student loan + $125 car insurance) is due before his next paycheque on the 15th. So he will be short by $412.50 ($1,137.50 – $1,550).
|
Amount |
Day of the Month |
Monthly after-tax income |
$3,750 |
|
Money You Cannot Spend |
||
Rent |
$1,000 |
1st |
Phone |
$100 |
20th |
Subscription |
$10 |
2nd |
Student loan minimum payment |
$65 |
4th |
Car payment |
$350 |
2nd |
Car insurance |
$125 |
5th |
Retirement savings |
$500 |
28th |
Student loan above-minimum payment |
$60 |
28th |
Car repairs ($500/year) |
$40 |
28th |
Gifts/holidays ($300/year) |
$25 |
28th |
Total Money You Cannot Spend |
$2,275 |
|
Total Money You Can Spend |
$1,475 |
|
“So you’re short by $412.50 when you kick off this new banking plan,” I said.
“Yikes! Okay, how do I get around that?” he asked.
“You will need to start this new banking plan with a $412.50 buffer in the Bills and Savings account. You can use $412.50 from your $3,000 in emergency savings.”
“Won’t that happen every month?” he asked.
“No, it will only be a problem for the first month. Watch.” I mapped out Jesse’s cash flow for the whole month on the banking plan.
Bills and Savings |
Transaction (Date) |
Balance Remaining |
Buffer deposit |
$412.50 |
|
Paycheque |
$1,137.50 (30th) |
$1,550 |
Next Month |
||
Rent |
$1,000 (1st) |
$550 |
Subscription |
$10 (2nd) |
$540 |
Car payment |
$350 (2nd) |
$ 190 |
Student loan minimum payment |
$65 (4th) |
$125 |
Car insurance |
$125 (5th) |
$0 |
Paycheque |
$1,137.50 (15th) |
$1,137.50 |
Phone |
$100 (20th) |
$1,037.50 |
Retirement savings |
$500 (28th) |
$537.50 |
Student loan above-minimum payment |
$60 (28th) |
$477.50 |
Car repairs |
$40 (28th) |
$437.50 |
Gifts/holidays |
$25 (28th) |
$412.50 |
Paycheque |
$1,137.50 (30th) |
$1,550 |
“See? At the end of the month you’ll have $1,550 again that will get you through the next month, and so on and so on. It’s only in the first month that this is an issue.”
“Ahh,” he said. “Got it.”
If this is something that you’re worried about too, map out every planned transaction that you have earmarked to come out of the Bills and Savings account and how often you will put in money from your paycheques. If there’s a shortage, you will need to start off the plan with that amount of money in the Bills and Savings account as a buffer. If you’ve got Short-Term Savings or a balance in your chequing account already, then you can use that. If you don’t have it saved up, see if you can change any of the dates of those transactions to come out later in the month, once you’ve had a chance to deposit two paycheques.
If there isn’t any wiggle room and you don’t have any Short-Term Savings or a balance in your chequing account right now, you’ll need to save it up. This may push forward the start date of your strategic banking plan, but it’s better to start off on the right foot.
Step 2: Spending Money
Since the money Jesse cannot spend ($1,137.50) is already taken care of in the Bills and Savings account, the money that he moves into his Spending account, his Hard Limit, is 100 percent guilt-free Spending Money. For Jesse we know that $1,137.50 from every paycheque must stay in his Bills and Savings account. So if his paycheque is $1,875, that means he has $737.50 left ($1,875 – $1,137.50) to blow to zero with every paycheque!
With every paycheque, Jesse should move $737.50 from his Bills and Savings account to his new Spending account. That way he isolates his Spending Money for the next 15 days, until the next paycheque.
Step 3: Automating the Bills and Savings account
Not only should Jesse automate as many of his Fixed Expenses as possible to be debited from his account, he should also automate the savings earmarked for various goals to ensure that they happen.
•
Four months after our meeting, Jesse and I checked in. He was very pleased. Not only had he met all his savings goals to date, he had been able to stop worrying about money each month.
“I feel like I won the time lottery,” he said. “I didn’t realize how much headspace money was taking up each month until I didn’t have to worry about it anymore. Now I know that when it’s payday, I have $737.50 for the next 15 days to eat, get around and enjoy life. Everything else happens behind the scenes and I don’t even have to think about it.”
Yes! I asked him if he felt that he had more control over his finances and a better grasp of what he could and could not afford.
“Definitely! It’s so liberating to know when I can and can’t afford something. I feel like someone opened the window and I can finally breathe.”
I smiled. “Exactly.”