Paying it forward
YNAB is an acronym for “You Need A Budget” and is what I use to manage my finances. All of these articles touch on YNAB in part or in whole.
It’s almost a new month and with spring on the way – despite how much of a chokehold winter may have on us now – my book is free to download all this weekend to help get you started on a new budget! Included with the book is a free bonus that you’ll want to check out so if you haven’t grabbed your copy yet please download it now.
P.S. Please be sure to tell your friends. ツ
After 2 months of self learning what I needed to do to get an ebook written, formatted and published my book “Paycheck to paycheck budgeting with YNAB” is available now on Amazon.
The cover pretty much tells what you’ll find inside but I’ve included steps on importing and reconciling as well to help new users cover all of the bases they’ll need as they get up to speed.
Now that it’s live I’m going to focus on another book (details soon) and with any luck it won’t take as long to go live. ツ
If you’ve ever listened to Dave Ramsey before then the title of this post sounds like it goes directly against what he would say. After all if you are struggling and are in such a dire position that you can’t pay all of your bills then this advice is wrong.
But what I’ll be talking about here is not what you should do in that situation but is instead geared toward those of you that are getting up to speed with your budgets. You are feeling good about how it all works and are looking for ways to save. This is one of those ways.
Aside from items such as food or transportation costs, two of the big players in your budget could well be loans and utilities. Lumped in with the utilities are any regular item that makes your life easier whether needed or not. For example:
Essentially any service for which you owe a monthly bill that is generally due around the same date each month. Loans of course behave in much the same way inasmuch that it’s a set payment and it is due once a month near or about always on the same day every month.
The trick is to understand the difference between the two. On the one hand you have the utilities, they provide a service, metered or not and are more than happy to wait until the actual payment due date in order to recieve the money that you owe. Paying them early is fine but honestly they don’t care and as long as it’s paid on or before the set due date then it won’t affect you (or your credit rating) one iota. The payment amount due is the same whether paid on time or paid early.
Loans however are different, the interest attached to them creeps up with every day. Paying it on the due date is perfectly okay with the lending institution of course but if you can pay it early then you gain.
How?
Easy, allow me to explain.
In most cases loans of all types are compounded daily. The trick then is to pay the loan payments as soon as you can and maintain that pattern which over time can save you a lot of money. Take for example a loan for $10,000 taken out for a period of 4 years. In this example let’s say that the interest rate being charged is 6%.
That being the case then it would breakdown something like this:
The way to understanding this is to understand how interest is calculated. The formula is generally rate divided by 12 (months in a year) times the principal balance equals interest due. In the very first month of our example loan $50 of the payment would be interest with the remaining $184.85 going to principal. The next month the same formula is applied and the interest charged would be a little less this month at $49.08 paid.
The thing is though, banks and other lending institutions don’t wait until the month is over to calculate the payment, they do it daily. If you take a close look at your paperwork or if you get a statement you will see a daily periodic rate that is simply a fraction of the interest rate being charged. In this case that amount would be around 0.0164%. Now, this may not seem like much but in the early days of your loan it amounts to over a dollar and a half per day. The meter is always running and even though it may not seem like much, knocking down what you have to pay even if only by pennies at a time is worth it and the effort required to do so is minimal.
Your goal then is to make that 0.0164% mean less and less by paying your payments as early as possible each month. When you do so you ultimately pay less over the life of the loan and at the same time you help maintain your good standing as a credit worthy person should that be your goal.
To summarize, if you are operating your budget using YNAB and you have a full buffer in place, then if it near the end of the month and you have most of your paychecks in the bank just waiting to go to work? Then take advantage of your position of being ahead and pay the loan payments due even if the due date is near the end of the next month. Even if over the life of the loan you can’t ever seem to get far enough ahead with your entire budget to pay more than the regular payments, this approach of paying early is nearly equal to paying just one extra payment over the life of the loan which will save you over $100 overall.
Not bad for simply paying loans first and utilities second.
If you’ve ever been to the YNAB forums before then you have more than likely heard of this thing called a “Buffer”. If I had to describe it in a line I would say that it’s simply a reserve of cash that you earned last month that you use this month to spend and save. The way to keep that going is nearly automatic since if you aren’t spending this month’s money then it is building up to become the buffer for next month.
But I digress, describing something by the scientific mechanics in which it lives just serves to confuse people. So with that in mind allow me to put it another way by painting a picture for you.
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Every month bills come due.
Some are predictable, others are not, but even the ones that aren’t predictable can be guessed at with a fair amount of accuracy. Then of course there are other expenses, food and gas usually top the list followed by entertainment. After that the list begins to narrow down to saving for annual expenses or rainy days. Normally most people approach each month – and the outflows of money that will occur – with dread since they most likely have to juggle paychecks and payments figuring out how to keep them all in the air without dropping one of the payments. Some people refer to it as “timing” your paychecks to match the payments. That fits I suppose but what if there were a better way?
Would you try it?
Imagine if you will that instead of receiving a paycheck once a week or every other (or whatever odd frequency) that instead you received a check on the first day of the month that equaled all of the paychecks that you would normally get in a month? If you take that as a good thing then consider what it would be like to sit down on the afternoon of the 1st day of each month and write out all of the checks, authorize all of the electronic payments and otherwise pay all of your bills in one sitting, one day a month. After that you would set aside enough money to float you through the month to pay for groceries, gasoline and entertainment with enough left over for short and long range plans as well.
If you were to do so then you would essentially be living under Rules 1, 2 & 3 of the YNAB methodology and by doing so you would eliminate (or at least seriously reduce) money stress in your life. Then, as long as you have your budget written down (or better yet in the YNAB software) you could take advantage of Rule 4 and “Live on Last Month’s Income”.
This my friend is all there is to what is known as the “Buffer”, one full month’s worth of expenses in cash saved up for and used to do exactly as I’ve described above.
The power of the buffer cannot be overestimated, strive for it and once you get there you won’t go back to juggling ever again.
When I was very young my grandparents opened a “Passbook” savings account for me and my older brother. I don’t recall the amount but it wasn’t so much about the cash as it was the concept. The idea – though it was likely lost on me at the age of 5 – was in order to have money for something I really wanted later I needed to save the money I had on me now.
As you might imagine it was a hard pill to swallow as I was already fully ingrained with the idea of stuff and money was my golden ticket to getting more stuff. Irregardless of my wants at the time though, the money stayed in the account and every so often I would be taken to the bank to learn the ropes and deposit some money I had been given for a birthday or perhaps Christmas. Though it never amounted to much it started me on the path of thinking that the place where I was holding my money defined what it was for.
In reality, nothing could be further from the truth.
Unfortunately, far too many people were brought up the same way and to this day ‘Savings’ accounts are a booming business for banks and even credit unions in the form of ‘Share Accounts’. Though I can’t postulate with any authority that the concept of savings account wasn’t much more than a marketing move many years ago I think it’s a fair bet to say that it’s probably not far from the truth. The simple but powerful idea that you need to save had banks lining up to help you do just that so that you’d deposit more making their business boom with the fuel of your dollars. But I digress.
When it comes right down to it my grandparents had it right. If I wanted to have money around later, or be able to purchase something expensive I had to save for it. The trick is, how to keep track of what all those dollars were doing for me, or, what I wanted them to do while they waited. The ‘Savings’ moniker was (and still is) too generic.
Enter budgeting. No, I don’t mean any sort of crystal ball, wet finger in the wind guess but instead a solid on paper (okay, computer) plan for what you expect and want to do with your money.
It’s really that simple and I may as well cut to the chase and tell you about the software that I use. It’s long name is You Need A Budget or YNAB (why-nab) for short. With it, I’m able to take all of the money that I have, decide what I want to do with it proactively, and then as long as I follow that plan I’ll gain. I won’t go into all of the details as to how it works here instead you should check out how savings work on their site. Suffice it to say though it allows you to decide what you want to do with your savings. Are you saving for a vacation? Then put it in a vacation category and it will be there when you’re ready to head out. Are you saving for just in case? If so then you can collect that and the money will be there when you desperately need it.
The bottom line though is this; it doesn’t matter where you save your money as the place that holding it is just a name, it’s just a container, what matters is what you plan to do with it.
So, why do you save?