I’m not stressed about our finances.
That doesn’t mean I’m not seriously focused on increasing income, paying off debt, and saving for the future. I think that’s healthy, motivating stress. It doesn’t mean there are no times that I feel overwhelmed by the size of the task and the measures we’ve taken to address it.
That does mean that I don’t live with the overwhelming, sickening sensation of constantly being almost drowned in financial troubles. I don’t feel like our situation makes me unhappy, scared, worried or short-tempered. If Stephanie has a contrary opinion, she’ll surely be in to correct me.
One reason for the low stress we feel about our finances is that we have built and maintain a cash buffer – one of the main strands of our financial safety net. More than anything else, our cash buffer eliminates the worry about meeting the bills and expenses of the month. In fact, as I began thinking about the different strands of a strong financial safety net for this series, the very first thing that came to mind was our cash buffer.
For us the cash buffer includes two parts.
- Living on last month’s income
- An emergency fund
Both pieces provide a cushion against large expenses or a change in income. We have talked about both of them before, but because a discussion of our financial safety net would be incomplete without them, we’ll cover them again.
Living on Last Month’s Income
I have to confess that I was hesitant when Stephanie first proposed living on last month’s income. Because nearly all our expenses are paid on a credit card, and our bills weren’t due until a month after the end of the statement period, we were generally living on the float. I loved the idea that the credit card companies were providing us a no-interest loan for all of our living expenses each month. It made me feel like I was winning the game, even when they had set up the rules.
But I knew my wife is a smart girl and if she was in love with the idea of living on last month’s income, it was probably a great idea. In addition, over the last few years she has become the manager of our family finances, so a change like this affected her more than me.
It turns out my wife is a genius.
Living on last month’s income works like this. In February, our family received a certain amount of income. Essentially, that income went into a jar labeled “March Expenses” and we never touched it during the month of February. Our only interaction with that income was to put it into the jar. On February 28, in our monthly budget review, we picked up the jar, counted it, and set the amounts in our budget expense categories for March to equal the amount in the jar. Then, we started paying March’s expenses out of February’s income. March’s income goes into a new jar labeled “April Expenses.”
(Note: We don’t actually have jars. The actual separation and allocation of funds is done in YNAB, our budgeting software of choice, which makes this really easy. Some people actually use jars, or envelopes, or some other method. As long as one month’s income is allocated for the next month’s expenses, the mechanism is less important.)
The beauty of this is that we know, on March 1, exactly how much money we have to spend in March, and we already have all the money waiting. We don’t worry about which expenses are due before the second paycheck, and if the first paycheck will cover them. We don’t worry about an unexpected change in March income leaving us unable to cover March expenses. The money for March expenses is already there. We don’t worry about getting busy and incurring a late fee because we forgot to pay our credit card balance on March 22; we already paid the statement balance at our February 28 monthly budget meeting. All we have to do in March is put our March income into our “April Expenses” jar, and live within our budget categories for the month.
But we have two older vehicles, each with over 200,000 miles on them. What if one of them dies in March? We don’t have large sink funds for car replacement. That’s a decision we made when we decided to focus strictly on paying off the student loans. I need a car to get to work. Stephanie needs a car to pick up the kids from school and handle all the other family business while I’m at work. We would have to purchase a car, and that’s not part of our budget categories. The safety net is built for times like this. This is when the emergency fund comes in.
I don’t think an emergency fund requires a lot of explanation. It’s a pretty common idea. You set money aside and just let it sit there until an emergency comes up. Our emergency fund right now is made up of just over $5,000 sitting in a savings account at Capital One earning a few dollars of interest each month.
We’ve never spent more than $3,500 on a car, so I hope that would be enough to make the purchase if we had to replace one. If both cars went out at the same time, or if some other large expenses came up, we’d be left with no emergency fund to speak of, so we’ll be adding to the emergency fund over the next several months, building it up so that after a large expense or two, we still have a meaningful safety net.
$5,000 is a pretty small emergency fund. Most financial gurus advise 3 – 6 months of living expenses. Ours is about 2-3 months of our current low living expenses, but we also have an additional month of buffer because we live on last month’s income. We’re running lean right now with our focus on paying off student loans, but we’re comfortable with it in our current circumstances. If our fixed expenses were higher, we’d have a larger amount set aside.
And that’s our cash buffer. We avoid the daily stress of wondering if our income can cover our bills by making sure we have an entire month of income sitting there, waiting for us, at the beginning of each month. We pay off all our credit card balances, using that income, at the beginning of the month, so we don’t have to remember which day the balance becomes due and we never worry about late fees. We keep an emergency fund on the side for larger expenses.
By itself, a cash buffer is not a full safety net, but a safety net without a solid cash buffer would have a huge hole in it.
It’s tax season, and many of you have just or will soon be receiving a tax refund. If you’re working towards living on last month’s income or building an emergency fund, that’s a great source of funds to get closer to those goals.
How About You?
- What do you have as your cash buffer?
Other posts in the Financial Safety Net Series
- Intro to Financial Safety Nets
- Why a Durable Power of Attorney is Part of Your Financial Safety Net
- Insurance We Do and Don’t Carry– Our Cost, Coverage and Reasons