If you have followed my blog / social, you will know that my wife and I were super fans of Dave Ramsey and "The Baby Steps". We were so bought in that we moved to Nashville so I could work for him for almost 10 years, and I evangelized that place hard while I worked there. I've talked about that a little in the past, but this post is not about that.
The entire time we followed that plan, it never set right with us how it made you plan based on income you had not yet been paid. Even after paying off debt, it left you living paycheck to paycheck, because your budget was based off of potential earnings in the coming month. If you are on a straight salary, like I was from 2005-2009, budgeting under than plan is actually quite easy, since you should be able to predict your income, assuming you didn't lose your job.
But while working for Dave, I had a lot of variability in income because he wanted everyone to feel the ebbs and flows of the business through some form of "profit sharing". (yes, he has a "plan" for that, I will get to that)
Please do not get me wrong. We were not struggling in 2010-2020. Though I do know now I was underpaid relative to the Nashville market, I was making decent money as a software engineer. And, my wife had a good income as a nurse, which had its own variability due to shift differentials and scheduling. What bugged us both was that it just didn't make much sense to budget based off of potential income, which for us varied by as much as about 40% from month-to-month.
Thankfully, after a year or so working there, one of my coworkers introduced us to this simple idea - budget based off of what you made the month before. This wasn't exactly 100% following the "plan", but it made things so much easier for us.
This is what I am talking about when it comes to variability. The pay structure for developers changed three times while I was there, but some form of profit "sharing" or commission was always present. In 2011 and 2012, the first check (around the 14th) was a lot lower than the second. The second (30th) would include the profit sharing / commission portion. January 2011 was 20% higher than December 2010, and March 2011 was almost 13% lower than February. Around this time the split was around 30% on the first check and 70% on the second.
There was also something unusual with my pay for the first year I was there. It included an unexplained line item labeled "bonus" in the first monthly check that varied from month to month (my department head just winked at me when I asked about it, never explained it). Though this was appreciated, it added another layer of uncertainty to the checks. Once that went away in May of 2012 (dropping my income noticeably), the checks on the 14th became very predictable, even if they were only about 30% of the month's income.
Over time this flipped, as can be seen in the 2019 and 2020 numbers - the red portion stays constant while the blue varies. The split was a lot more even - about 55/45, a nice improvement from the 30/70 from the early years. My last two full months there, when COVID hit, the pay checks were 50/50, as profit sharing had been suspended.
Irregular Income Plan
But the purist may ask - what about Dave's "Irregular Income Planning" form? I'm quite familiar with it, at least the older versions. In case you aren't, here are a couple versions through the years:
The way this form was laid out when we were followers was to list expenses in a priority order. A mortgage payment or rent would be at the top, as would groceries, gas, insurance, etc. The idea was there would be some items at the bottom of the list - likely savings goals, extra payments on debts, sinking funds, etc - that might not be paid in a given month if the irregular income was low. I still think this is a good exercise, even if one used a different budget strategy. That is an exercise that can feed into planning for an emergency fund - knowing what has to be paid, and what can be skipped if one lost their income for a short period of time.
But to us, we didn't feel that the irregular income form was for us. By the time we moved to Tennessee to work for Dave, we had paid off all of our consumer and student debts, and were making enough that we could cover all of our expenses with some left over most months, even with the variability in income. Savings goals would change from month to month, but actual expenses were always covered.
I do like how in the current version of the "irregular income" form encourages figuring out the "lowest irregular paycheck in the last few months", and to budget off of that. That is slightly different, event more conservative, than saying "budget off of last month's income". Had the irregular income form been worded this way years ago, it likely would have served us better.
Aging Your Money
Back to the idea planted by my coworker. It turns out this is closely aligned with a strategy called "Aging Your Money" by the folks that make the budgeting software YNAB (which we have used for over 10 years, even while working for Ramsey).
This is one step past budgeting off of last months income. We started by looking at the previous month's income, coming up with a budget based on that, but our checking account would still be way below that level at the start of the month. Aging your money involves building up a buffer to the point that when you make your budget, you are doing so based on money you actually have, and that money should all be "30 days old".
The YNAB folks talk about this strategy here. I will be honest though, I still don't fully grasp the way they calculate Age of Money. We use YNAB, and the age is consistently well above 100 days, but maybe that is because our emergency fund, and some other funds, are present as accounts on our budget.
Another budgeting app, Goodbudget, describes this as a cushion in their article about How to Stop Living Paycheck to Paycheck:
While breaking the paycheck to paycheck cycle isn’t easy, it starts with working towards building a cushion in your budget. When you have one month’s worth of expenses, it’s a cushion that helps you pay this month’s bills and fill your Envelopes in Goodbudget with money you earned last month.
The rule we have tried to follow in our house though for many years is simpler - come the final day of a month, our checking account, minus any balance on a credit card, should equal or exceed what we made in that month. If we had paychecks of 2000, 2500, 1500 and 1250, or $7,250 total, and had a balance of $1000 on a card that was due to be paid automatically the first week of the coming month, our budget should be $6,250.
This is what our income, expenses, and running balance look like after making this change. You can see that our checking account hit near zero, and never came close to even half of our previous month's income. After making the change, our checking account would hover closer to the previous month's income, instead of $0. This chart hopefully shows that we were aiming for our checking account to equal the previous month's income around the time the month started, not to maintain a 1 month's income as a balance for the entire month.
How To Get There?
In order for this particular strategy to work, you have to build up a 1 month of income buffer or cushion somewhere, such as a checking or savings account. For some this could take many months if not a couple years. Just like saving for "3-6 months of expenses" into an emergency fund, saving one month's worth of income will require some time, and that time will vary from family to family.
Anyhow, this worked for us, and finally gave us some stability in how we budgeted. Maybe someone else will find that useful. As I have started to become fond of saying since parting ways with Dave, "personal finance is personal". Find what works for you.