This is the final part of my entry series into YNAB, the budgeting software I use to budget without feeling restricted.
This fourth post is about ageing your money.
The Age of Money
After you’ve given every euro a job, embraced your true expenses, and are rolling with the punches, the last step to take is ageing your hard earned money. You need to do this so that you can live on last month’s income and thus break the paycheck-to-paycheck cycle.
Have you ever postponed paying a bill because you get your salary in a couple of days? If so, you really need this YNAB rule number four. This rule makes you build up a cash buffer of at least a month, so that you no longer have to float your expenses towards your salary.
How does this work? By saving money you grow your financial buffer. This means that more and more money is piling up in your bank account. One day, this buffer is large enough to pay the rent or mortgage for the next month. Yeah, you’re now living on old money, on money that you earned in the past.
Making Your Money Older
By growing your buffer more and more, your money grows older and older. There comes the moment that you can fill all your budget categories for the next month with your salary of this month. You now live by rule four. Your money is officially one month old and you’ve broken the cycle of living paycheck-to-paycheck.
From now on, you can increase your buffer to a couple months of expenses, investing in the future by buying ETFs or paying off debt, whatever you wish. You’ve taken the first couple steps to financial freedom.
How Old is Your Money?
I usually try to explain rule four by using an example.
Say, you live in the middle of nowhere. Your home is not connected to the power grid. That means you have to generate your own electricity, using a generator running on diesel. Every month you use your diesel to provide you with power. At the end of the month, when your fuel is almost used up, a new shipment arrives and 100 liters of diesel are poured into the tank.
You are definitely in the delivery-to-delivery cycle here. What if the fuel truck is a couple of days late next month? What if you need to use more electricity because of other reasons and you’re running out of diesel early?
By being smarter with your energy usage you could mitigate a lot of these risks. Instead of using 100 liters every month, would it be possible to just use 90 liters? Then next month, when the truck is delivering its load, you have 110 liters of diesel in your tank. Every month you keep using 10 liters less than what you get. At the end of the year, a whopping 120 liters of diesel is saved up, or more than an entire month’s worth of usage.
The average age of the diesel in your tank is getting older and older. New diesel is put on top of older diesel, that is used first (I know things don’t work this way with liquids, but bear with me). With your old diesel at the bottom of the fuel tank, you are not using the fuel you get this month at all. Your diesel is over a month old and you’re living on last month’s delivery and not this.
The same things goes with your money. By not spending the money you are going to receive this month, but spending money you earned last month, your financial situation will be so much more relaxed! Your cashflow is more stable, you know you can pay all your bills on time, and when your salary is transferred a couple of days late that’s no big deal.
According to my YNAB account my money is 52 days old, but that number is slightly misleading. It means that the average age of the money I spent in the last couple of transactions is 52 days. In other words, I’m spending money that has been sitting in my budget for 52 days. This is not entirely true, since I also “spend” money by transferring funds to my investment account. So in reality my money is slightly older than those 52 days. How old is your money?