How to achieve financial serenity

Without a plan, your budget alone is naive

For at least 10 years, I thought that all of my financial problems in life could be solved with budgeting.

The moment of clarity came when I realized that despite all my fastidious budgeting activity, I was actually moving backwards and didn’t even realize it.

The backward drift was easy to miss because, if I’m being honest, I didn’t really know where I was headed. I just knew that if I had some savings, things weren’t so bad.

I couldn’t see the limitations of budgeting until I realized that I was operating without a plan.

Budgeting has its place. And its limits

I’ve been an avid budgeter since 2012 and in that time I’ve gone from a complete financial mess to finally getting my spending under control.

If you’re living paycheck to paycheck, like I was after graduating college, starting a budgeting habit is the single best thing you can do to improve your financial situation.

The limitations of budgeting only become important after you’ve moved on to calmer financial waters.

I’ve been laid off five times over the course of my career, and for the majority of those periods of unemployment, knowing I could afford to live off savings for several months at a time was enough to keep stress and anxiety at bay.

It was only during a year-long sabbatical (layoff number 4) that I had the mental space and distance to realize that I was in a loop. When I had a job, budgeting helped me rebuild the savings spent during the prior layoff. When I was between jobs, budgeting helped me stretch my savings until I could land on my feet again.

Budgeting was essential to keeping my head above water during turbulent times, but all the budgeting in the world wasn’t going to help me determine when I was ‘financially fit’ enough to transition from perpetually playing defense (i.e. saving for the next rainy day) to investing in a new path forward that could finally break the cycle.

Budgets lack context

Not all spending is equal. Shelling out $1,000 for a car repair is perfectly fine if you’ve saved for it in advance (budget nerds call this a sinking fund.) Spending $1,000 on an impromptu long weekend is toxic if you can’t afford it.

Your budget can’t tell the difference between the two. If you ended up overspending on one category, your budget will force you to pull money from other places to cover the shortfall.

If those other places include your emergency nest egg, the feeling of responsibility you have when covering the shortfall can hide the fact that you’re actually losing ground in the big picture. This was what was happening to me during the sabbatical.

Budgets don’t know what they don’t know

A good budgeting app allows you to save for future expenses like insurance premiums and anticipated repairs, but it won’t tell you if you’re saving for everything you should be.

Did you remember create a savings category for that old water heater that’s about to die? Are you on track to pay the annual fee on that fancy travel credit card?

Budgets leave it to you to determine what goes in them, so if you’re missing something important, your budget is none the wiser.

Budgets don’t tell you what to prioritize

Even if you did a great job identifying all the things that you should be saving for, if you’re like most of us, you can’t fund everything at once.

You only bring in so much each month and your budget leaves it to you decide which categories to contribute to now, and which to contribute to down the road.

Your budget does a great job of displaying all the places you could park you money, but doesn’t have anything to say about which categories to fund first. This is where a plan comes in.

The utility of a plan

A plan charts your path from financial infancy to mastery. It’s a roadmap, a set of principles, and a safety net, all rolled into one.

To understand how a plan fits into your financial life, it’s best to describe the job it does relative to your budget.

Think of your budget like your maps app, dutifully spitting out turn-by-turn directions to get from point A to B. Your plan operates on a higher level, telling you that you’re headed on a road trip and identifying the stops along the way.

A plan and a budget are perfect compliments

A plan wonderfully addresses the limitations of a budget.

• It provides the context missing from your budget by giving you a way to measure progress toward a set of milestones, allowing you to clearly discern good spending from bad.

• The very act of creating your plan ensures that your budget is comprehensive and complete. No more getting caught off guard by foreseeable expenses.

• Your plan sequences your savings goals so that the most urgent and important items are taken care first. When you know where you’re going, and how you’re getting there, prioritization is built in.

• Your plan gives you a sense of place, showing you how far you’ve come and how much is left to go. It’s like seeing the “you are here” arrow on a map.

3 Steps to creating your plan

Step 0: Start (or restart) using a budgeting app.

A budgeting app is crucial to tracking and planning your spending. The numbers in your budget will serve as the foundation for all of your decision making.

You really can’t define a proper plan until this piece is in place. While there are many budgeting apps to choose from, I love You Need a Budget (YNAB).

Step 1: Set up your budgeting groups

Your budget is made up of categories (groceries, rent, clothing, etc.) organized into groups. A strategic set of groups is what allows you to connect your budget to a plan.

After experimenting with several variations of groups over the years, these six are the most impactful:

Everyday Expenses

This group holds categories for expenses that are regular, predictable, and that happen multiple times a month.

Examples include rent and utilities, groceries, dining out, clothing, and household goods. If you have a category that doesn’t fall in any of the following groups, it probably belongs here.

Debts

All debt payments you’re currently keeping up with on a monthly basis. Think mortgage, car loan, student loan, and credit card minimums.

Scheduled Spending

Future expenses where you know the date and amount of your next payment.

Examples include annual credit card fees, your AAA membership, and semi-annual insurance premiums.

Rainy day funds

Future expenses that you can see coming, but whose dates are unknown. This is effectively how we account for Murphy’s Law which states ‘anything that can go wrong will go wrong.’

Examples include insurance deductibles, home repairs, and replacing appliances.

Aspirational spending

These are optional (and fun) expenses you’d like to be able to make one day.

Examples include vacations, toys, charitable giving, and big ticket items like a new car or computer.

Emergency reserve

This is actually a single category that acts as a safety net of last resort. Unlike the other groups, this category has a one-way valve. You only touch it if and when you lose a significant portion of your income.

Step 2: Determine your milestones

Your plan is made up of three sequential milestones, each representing a significant developmental stage on your path toward Financial Serenity (we’ll get to this in a bit).

Achieving all three milestones will likely take along time (years not months), but the end point is life changing and well worth the effort.

Milestone 1: True Breakeven

You achieve this milestone when your monthly income covers your actual spending in addition to saving toward your Scheduled Expenses.

Example:

Let’s say you make $1,000 a month and spend $900 of it just living life. Let’s also say you have a $1,200 car insurance payment coming up in 6 months.

In Step 1, you added the car insurance premium category to your Scheduled Spending budget group, which means that you need to be saving (and not spending) $200 each month to be on schedule to make the payment on time.

In this simple example, you wouldn’t be at True Breakeven because your income of $1,000 doesn’t cover your actual spending ($900) plus the savings needed for the car insurance premium ($200).

To achieve True Breakeven, you’d either need to spend $100 fewer actual dollars or find a way to make an additional $100 over the course of the month.

When you hit Monthly Breakeven, it’s impossible to live paycheck to paycheck. By definition, you’re spending less than you make. The days of being caught off guard by a big, predictable, expense are over, and you’re ready to graduate to the next milestone.

Milestone 2: Financial resilience

You achieve Financial Resilience when all of the budget categories in your Rainy Day funds are filled.

In order to make progress in this stage, your monthly income must exceed your Monthly Breakeven amount.

In our previous example, you’d have to make at least $1,100 a month to make headway in this stage.

This milestone took the longest for me to achieve (nearly three years) but was also the most satisfying. Each budget category is like a mini-savings account dedicated to neutralizing a threat.

Every few months I’d fully fund another category, shortening the list of potential threats that could afflict me, and adding another layer to my financial armor. Your plan ensures that this is a finite list, meaning that you’re not going to be saving forever.

Once you fully fund the last of the Rainy Day categories, you finally switch from playing defense to playing offense, and it’s where things start to get fun.

Milestone 3: Financial Serenity

You achieve Financial Serenity when your Emergency Reserve is equal to 6 times your average monthly spending across the Everyday, Debts, and Scheduled Spending budget groups.

Because you covered all your worst case scenarios when achieving the first two milestones, you can take the scenic route on this final leg of your journey.

Feel free to siphon off some of your excess income toward funding one or two of your aspirational expenses with the remainder going toward filling your Emergency Reserve.

A worthwhile journey

While achieving all three milestones undoubtedly takes a long time to complete, the benefits kick in immediately and continue to build throughout the journey.

By the time you achieve Financial Serenity, each of the following will have come true:

• All of your monthly expenses are covered and, taken together, only amount to a fraction of your income.

• Each of your Scheduled Expenses are on track to be paid one time, meaning that you’re never caught flat footed.

• You can take a punch and are ready for anything. Murphy’s Law becomes a vanishingly small threat to your financial life until it’s gone completely.

• You’re spending money on things that are actually fun with no guilt or apprehension.

• You’ve got a stockpile of cash that can sustain you for a meaningful period of time in the event you lose your income.

Budgeting is an important skill to have for anyone serious about improving their financial situation, but without a larger strategy to guide your efforts, it’s all too easy to let the busy work of budgeting feel like progress.

With a clear plan, diligent saving, and a few lucky breaks, it took me roughly five years to achieve Financial Serenity. Ironically this happened the same month as my most recent layoff (number 5).

Unlike prior layoffs, I now find myself in a position of strength. I have the leeway to teach myself new skills to switch careers into something more stable, and I look forward to making this the most productive layoff yet.

A big part of turning these layoff lemons into lemonade is sharing tough lessons I’ve learned the hard way with you through this newsletter. Consider subscribing if you’ve gotten something from this piece.