This is a guest post from Andrew Selby. Andrew writes about debt management programs at his Debt Consolidation Blog.
Some reader stories contain general advice; others are examples of how a GRS reader achieved financial success or failure. These stories feature folks with all levels of financial maturity and income. Want submit your own reader story? Here's how.
After fighting, scratching and clawing for years, I had finally paid off my college loans and was completely debt-free. I achieved what most people think is impossible. Debt had put my life in the camel clutch, and I had finally managed to break the hold. Then, just when I thought I had conquered debt, I let my guard down.
I'm debt-free!
After the first few months of living my debt-free lifestyle, I let the “free” part go to my head. If I wanted some new clothes, I didn't think twice about charging them to my credit card. Why not, right? I was debt-free. I could just pay the balance at the end of the month.
Then, a few weeks later I would find a piece of furniture I wanted. No big deal, right? I'll just charge it now and pay off the balance later. After all, I'm debt-free.
After a few months of making these types of poor decisions, I realized that I had piled up a few thousand dollars in credit card debt. Whoops! It was no problem, though. I had already paid of over $40,000 in student loan debt, so what's a few thousand? So I would hunker down for a few months until I had all zero balances. Then I would revert right back to my debt-free mentality and repeat the cycle.
I went through this cycle about eight times over three years before I realized that, despite being technically debt-free, I still wasn't any further ahead than when I paid off my debts for the first time. That is when I realized that in order to manage my money responsibly, I would have to limit my access it. I was never going to be able to make good decisions in the face of temptation. I'm just not that responsible.
I'm not alone!
As I began to see that I was trapped in a rat race that I wasn't going to be able to get out of, I also noticed how many other people were doing the same thing. My girlfriend, who has since become my debt-free wife, confessed to me that despite paying off over $10,000 in credit card debt, she had charged herself right back up to the same amount.
Everywhere I looked, I saw people who were trying so hard to get out of debt making the same mistakes I was making. There appeared to be many people, just like me, who would get to the end of the month and wish they hadn't charged those fancy dinners because they didn't have enough left to pay the electric bill.
Maybe a budget will help!
Like any smart, ambitious, personal finance student would do, I concluded that I would have to write out a monthly budget. However, this didn't help to address my core problem. I am just not responsible enough to stick to a budget. I just can't say no to spending, even though I should be saving the money for bills.
Ding! That was the answer! I just need to keep as much of my income as far out of reach as possible! Thus, the Waterfall Money Management System was born.
The Waterfall Money Management System
The simple idea of my Waterfall System is that the less money that I allow myself access to, the less money I can blow on unnecessary expenses. Here's how it works:
Three expense categories
The first thing I did was separate each of my monthly expenses into one of three categories. Since I already had a monthly budget, this was pretty easy.
The first category was the most important. This was all of my debts that needed to be paid off. After I paid off all of my debts for the last time, this category became my savings, investment, and retirement money.
The second category contained all of my living expenses. This included my mortgage payment, utilities and cable bill. These were expenses that were necessary to provide my budgeted lifestyle and could be reasonably estimated each month.
The third category was all other expenses, which I considerd non-necessities. This included groceries, clothes, restaurants, entertainment and other such things. (I understand that food and clothing are in fact necessities, but I have a habit of rationalizing overspending on those items, hence I group them as non-necessities.)
I broke down how much I made and calculated the average cost of each of my expenses. This proved my suspicion that I was simply overspending on non-necessities.
The key component
None of this was very significant up to this point. All I had done was put together a categorized budget and prove that I was living above my means. How could I force myself to cut back on my excess spending?
The idea actually came to me completely by chance. All in the same day, I was struggling with my personal budget issues, was asked to open a free checking account at a local bank, and was updating the direct deposit information for an employee at work.
I realized at that moment that I could open separate checking accounts for each of my expense categories. I could then calculate the monthly cost of each category and set up my paycheck to be directly deposited into three different accounts based on priority. This idea would have my income flowing through the accounts in order, much like a waterfall.
The first priority was my debt payment plan, which was a fixed monthly amount, so I would designate that amount to come off the top of my paycheck and go into the first bank account. The second priority was my standard, budgeted living expenses. I set the average cost of those bills, plus a little extra just in case, to be taken from my paycheck into the second account. Then I had whatever was left of my paycheck put into the third account for the rest of my expenses.
The first two accounts have no debit cards or checks. Every single expense is automatically debited from the accounts each month, so the entire system runs independent of me. (An added bonus has been that I have not been charged a late fee since switching to this system!) I simply check the account weekly to make sure that the bills are being debited correctly. If there is ever a problem, I transfer money from my free spending account to cover the difference, but never the other way around.
I have a debit card for the third account, but prefer to withdraw the cash and spend it as needed. Since I am paid on a weekly basis, I only have to budget for seven days, which is very manageable.
Two years later
Early on in my adoption of the Waterfall Money Management System, I realized that there was one major flaw: It was too easy to jump onto my bank website and transfer money between my accounts. Before this had the chance to sabotage my plan, I came up with a simple solution: use different banks.
Today, my debt payment account has become a nicely funded savings account with a local credit union. I have set this account up so that the only way I can withdraw money is to physically go to the credit union during banking hours. This has prevented countless late-night bad decisions.
My other two accounts are with two different local banks, so there is no interaction between the accounts. If I have an unusually large electric or gas bill, I simply withdraw some money from my free spending account and put it into my bill-payment account.
Limiting the amount of my money that I have access to has completely changed my life. For years, I would lay awake in the middle of the night worrying about how on earth I was going to make whatever payment was due that week. Now, I honestly haven't worried about missing a payment in years. Everything is handled for me before I have a chance to mess it up. It has brought an unbelievable peace to my life. I now know how it truly feels to be debt-free!
Have you used a money management system like this? Which system works best for you?
I think this is the most awesome plan I have ever read about, and I am going to implement it right away. My husband and I have the same problem with access to our money, and we’ve tried separate accounts but it’s so easy to transfer. This plan solves that problem! Thanks!
Thanks, Alison! I’m glad you found it useful! It has worked wonders for my wife and I!
Really great and imaginative solution for dealing with overspending. I laughed as a read your post. Did I write the part about getting out of big debt and figuring if I could do that, then paying off the monthly credit card bill was easy? I’m sure this resonates with many others.
Thank you for sharing this most useful system with us.
Thank you for the kind words, Janice! I’m glad you liked it!
I’m not this strict, but I do have money taken out of my bank account the day after my paycheck. That money automatically goes to my ING (now CapitolOne) savings account. I set a savings goal based on similar info — what are my monthly necessary expenses? I roughly know how much I have leftover for wants.
That said, I’m fairly good with money naturally, so I don’t have to be so strict. I think this plan looks awesome for those who need more discipline. I especially like the idea of having accounts that are hard to access. That was key for me in setting up ING for my savings accounts instead of just transferring to a savings account linked to my checking.
Leah,
I was actually using an ING account that was automatically debited before I set this system up! Of course, I raided it everytime my credit card balances crept up, so it never amounted to anything, but the idea is similar!
Thanks for your input!
Creative idea. You might enjoy David Bach’s “Automatic Millionaire” for ideas about saving. I found the most painless way to save was to save raises, COLA’s and windfall money. 70% in savings, the rest to enjoy and compensate for inflation. Good post, thanks.
I’ve been putting my COLA raise into my 401k for many years. Last year I actually maxed out my 401k, including the $5,000 extra allowed for those over 50. This year I’ll finally net an increase. It’s been difficult to have my net income stay flat for many years on end but I’m 6 years away from retirement and my 401k balance looks awesome!
Joe & Debbi,
That is an excellent point! I actually received a pretty large raise the same week I got married. The plan was to put the entire raise into savings each week, but having a new bride made that difficult. I was not used to things like having to buy groceries and cleaning products.
However, my wife and I are getting much better and have been able to back down our expenses and work the savings portion of our income up to where it should have been from the beginning.
Excellent post so true for me, will be starting this with immediate effect,thanks
Thanks, Daren!
I love this idea! Iwas wondering how you deal with quarterly or biannual payments such as insurance bills. thank you so much.
All of my insurance bills are monthly, however my water/sewage bill comes quarterly. I just looked at what it averaged over the past year and used that to conservatively estimate how much I needed to budget per month to cover it in the future.
This is great advice. I’m a college student and managing money is always hard. I waited after Christmas to buy myself gifts with the money I received, and I pick useful stuff, such as an external hard drive.
That sounds like a dream!
The usually get hundreds of dollars worth of stuff I don’t need and won’t ever use for Christmas! Such a waste.
I use a system very similar to this. The biggest thing for me is that I transfer money into a separate checking account every week that I use for everyday spending like groceries, gas, going out to eat, and other little stuff that I want for myself. I call this my adult allowance. I also told my bank I don’t want overdraft. If I don’t have money in the account it’s just declined. When I first started the system I sent this money to my account monthly but I would spend it all in the first couple weeks so now I do it weekly. It keeps me in line without me having to track every penny.
I would never be able to budget a whole month at a time. Fortunately for me, I get paid weekly, so there is less for me to worry about there!
I use a money management program and budgeting tool called YNAB, which stands for You Need A Budget. The link is here:
http://www.youneedabudget.com/
The premise is a bit hard to understand but I’ll give it a go. On first blush it looks like any other budgeting tool, however there is a real and huge difference. Every dollar you make THIS month is saved unspent in the bank. That money is used to set your budget for NEXT month.
Why is that so revolutionary? The one big difference for me is I never have to worry if there is enough money in the bank to pay the bills. I already know how much money I have, since I was paid the money last month. It gives a real sense of security and peace of mind. No more pay check to pay check existence. It still requires some self control but combined with the posters system , it could be quite good. Just my two cents.
BTW, I have no affiliation with the maker of the software, I just like using it and have done so for more than fifteen years. It’s really given me the ability to pay off my debts and save a substantial amount of money.
That sounds like a great idea if you are responsible enough to manage an entire months pay, which it sounds like you are. I used to do something similar, but I always found myself running out of money because of reckless spending early in the month.
Glad to hear you have a budgeting plan that works for you!
Awesome article, Andrew! Very similar to what I use, and teach – but we arrived at it in different ways.
Category 1 is the same as yours: first debt repayment, then saving (including saving emergency funds) and investment.
Our difference is that I label category 2 as “precommitted” expenses – spending that I’m already obligated to do before the month even begins. I like that better than “necessity vs. not,” because it’s a very simple, unambiguous distinction.
Then category 3, like you, is “everything else.” Not surprisingly, I have more fun spending from this category than the other two. I’m not going to cut down on category 1, so the only way I can get more category 3 money is by taking a harder look at category 2. So, there’s built in motivation to really economize on rent, cable/internet/cell phone contracts, etc. because every dollar I can get out of those goes straight into “more fun.” And it’s guilt-free fun, because I know I’m already providing for the future via category 1.
Thanks, Chris!
I really like the term “pre-committed expenses.” That describes them far better than I did!
I completely agree with you on the guilt free spending aspect. It’s a great feeling to purchase something silly and have no regrets because your more important priorities are already taken care of!
Brilliant idea, and well written post. Thanks for sharing!
Thanks, Laura!
Great post! I have a savings plan as well, but I never took it this far. When I filled out my job’s direct deposit form, I simply made it so that 10% of my check is always put into my savings account first, and the rest is in my checkings account. That way I don’t really think about it as “spending” money that I have. :) It’s worked for me.
This post has a great idea though. I just might open another account for bills.
Glad to hear you’re already using a portion of the system! It really is a great idea, and so simple. I am always amazed at how few of the 50+ employee paycheck I process take advantage of it.
You write that the first two accounts have no debit cards or checks. It seems like every checking account automatically comes with a debit card. So, do you “get rid” of the cards? Do you cut them up? Not activate them? Thanks for your help!
I simply told the banks that I didn’t want them when I opened the account. Cutting them up would work too, though!
great post: good idea, easy to implement. And that´s all it takes.. thanks for sharing!
Thanks, Luzi!
Andrew, I really like that you have shared your idea. I started using 3 bank accounts back in the 1980’s when bank fees weren’t around. Using a variation of your “Waterfall Money Management System”, I stopped working full-time after 25 years. Now I do what I like instead of spending my precious time just trying to stay ahead. Keep with the system and you will be rewarded.
The only thing I would add is to reiterate a previous comment…. Take your pay increases and put 70% in the investment account. I call it that because, by following your method, you won’t be in debt very long and you can used the accumulated money to invest in your future.
Thanks, Denise!
I definitely will! I am expecting a bonus at the end of the month that is going straight into the investment account!
Andrew,
Great idea and something that I practice. We have a lot of our money “locked” up in accounts that would take a week or more to get at. This keeps us away from spending too much!
HAHA! I love the term “locked up.” That describes it perfectly!
Wow, that sounds like a lot of work to just keep yourself from accessing your own money. It’s awesome that you created a system that works for you. Luckily, I don’t have that issue. My wife and I have a monthly budget and we’re pretty good at sticking to it. I’m not a natural spender, so it’s pretty easy to avoid spending money if I don’t actually need the product.
It takes some effort to get everything set up right, but once it’s up and running it’s very efficient.
My wife and I are the definition of natural spenders, so it really is necessary for us!
This is very similar to David Bach’s plan in “The Automatic Millionaire.” I’ve used his ideas for several years and it’s made a huge difference in both my savings and ability to stay within a budget.
I listened to that book on tape years ago, so its very possible that it was the root of the system.
I do something similar to this. Checking account for essentials, Savings acocunt for Investments. I broke my non-essentials / savings down even further because I said I was saving money for a trip or a new car, but noticed that I was spending most of that category each time something came up (like a vacation.) Thus, every time something came up I wiped out my savings goals for other stuff.
My wife and I have about 10 different Capital One 360 (ING Direct) accounts for our various savings goals. This keeps the money available for the various things we’re saving for. Money goes in automatically every month, and only gets used for that category. It’s annoying at Tax time and it’s a little easier to get to the money, but I can easily see how much I have saved for each thing.
Wow! 10 accounts! That’s impressive. Perhaps I haven’t taken this idea far enough yet!
Thanks, Jerry
Not a bad idea at all. I’ve found that automating debt payments (in your case, substitute retirement savings) has been a huge help in getting rid of temptation. I do this through direct deposits into an account that I only use as a pass-through.
That’s great! Glad to hear you’re on your way!
I don’t understand the waterfall analogy, but many of your methods match ours.
First, we keep debt under control by not getting into debt so therefore we only use cash or debit for day to day spending. We do have a credit card and will use it for travel and the like. We also do use Home Depot credit but that is really a business expense and the debt is only incurred when its 0% and then our tenants pay it off.
Second, I pay all our bills, move money to savings (mostly automated) and then we each have our allowance, which is what we can spend day to day every two weeks. ]
So, we increase our savings and we avoid debt by not using credit cards, limiting our spending by using the allowance system and we move savings off site (to ING, now know as Capital One 360).
Sounds like you have a very similar system!
i use the waterfall analogy because the income flows from the top priority down to the bottom priority one by one, like a multi-tiered waterfall.
It’s great that you recognize your weaknesses and have developed a method to outsmart yourself. Keep up the good work.
Thanks, Debi! Outsmarting myself is a great way to describe it!
Never heard the shiny phrase ‘waterfall money management system’ but it’s my system too. I use YNAB to keep my money in line.
It’s just ‘paying yourself first’!
Every two weeks when I get paid I auto commit a large, fixed percentage to savings & CC repayments (will be fully out of consumer debt in 12 months!).
After that are my immediate fixed expenses — utilities, rent, etc.
And after that is money I can spend guilt-free on eating out, entertainment, etc. Any money left over after the first two rounds of allocation is money I’m free to spend — after all, I’m meeting all of my savings goals!
You got it, Michelle!
The only difference is that I have to use the separate accounts because I’m just not very responsible.
Great premise but seems like a lot of work. I also use You Need A Budget (YNAB) as some others here.
What’s great about it is you don’t need to keep separating accounts, you can pay yourself first (that’s what I do), you can save money toward expenses that you know will come and you know you’ll need money for but don’t have right now (birthday parties, car repairs, license renewals, tax accountants, etc)., and there is flexibility to adjust your spending.
You can put x amount of dollars a month toward a category such as new shoes. Maybe you don’t have a particular pair in mind but know that you will need new shoes at some point. The time comes, the money is there waiting to be spent.
Instead of a budget, I like to think of it as a spending plan since I’ve paid myself first, I get to play with what’s left.
Thanks, Jennifer! That sounds great!
YNAB is a great method. combine it with Dave Ramsey’s principal of changing behavior to fix your financial habits, and you are golden. I was bad at saving until I started tracking and budgeting all of my spending. once you see where the money is actually going vs where you want it to go, your behavior does a 180 degree turn.
That is absolutely true, but my problem has always been ordering a shiny new toy late at night or on a sunday afternoon. Keeping my savings unavailable at those times has put an end to that.
Two words for you, Andrew:
Impulse Control
Until you master this skill, you will always be at risk of running up debt. You can set up all the artificial hurdles to trick yourself into saving you want, but if you don’t learn to manage your spending, you will never be free from financial worry.
The complicated system you have set up may have its benefits, but it does not cure the root problem. It’s so much easier to learn to manage your wants internally than to jump through all those hoops. Do this and you will begin to experience true financial freedom.
I completely agree. Everytime I see “creative” budgets like this, I feel like it’s over-sheltering, and building a wall around the main problem.
I’ve found that the real change in my financial ways came from yes, being conscious of how I spend my money, but even more so in replacing that desire for things that didn’t really benefit my life, with things that do (and usually those things are free).
It’s a change of mind and awareness, not methods and accounts. I agree that it’s better than nothing, so if it works for you in the meantime then that’s great! But do try some work on your worldview as well…you mind find even more.
I completely agree. The system treats a symptom of a bigger problem.
However, it also keeps me moving in the right direction while I work on those problems. My wife and I look at our spending as an addiction. We know from experience that we can be clean and sober for months and then, whoops, charge a $7k vacation.
We’re miles ahead of where we used to be, and while we continue to improve, this system provides guardrails to keep up on track.
I can see where you are coming from but I don’t agree. I also have impulse control issues. I started out using the exact same program as the author about 15 years ago but tweaked and refined it. I’ve tried and tried and tried to “work on” my impulse issues. But i’ve never found a book that truly helped and fast ran out of money going to a live person for help. So I gave up about 10 years ago. Because of my complicated system, I haven’t had a problem since. Now I don’t have to worry about it anymore. I’m at peace. Yes, my system is just a little more complicated than the author’s, but it’s also very automated. I don’t have to do a lot. You get used to it and I feel relieved actually, with my system.
Now I no longer feel guilty about not being a more “responsible” spender or money manager. I feel very responsible because my system keeps me in check. I no longer waste time trying to conquer my weakness. I focus on my strengths. (I felt very validated on this when I read Strength’s Finder).
Not everyone is made the same and a person only has so much willpower. Why make myself feel bad about this weakness when there is a system in place to counteract it? I have other financial strengths that I focus on. I will never try to get over my lack of impulse control. For me that’s a waste of time. But I want to reiterate that I have a mechanism in place to counteract it. I’m not just ignoring the problem and continuing with a negative behavior.
I just bring it up so that people like us don’t have to feel they need to conquer this. Especially when it’s people who don’t have this problem telling us we need to conquer it. You just need something to stop the negative behavior in a positive and healthy way. So kudos to the author.
Well put, Laura!
I couldn’t agree more. Trying to turn myself into someone capable of that kind of responsibility would be a mammoth task!
I also like to keep in mind that it wouldn’t just be myself who suffered if I took that approach and failed. My whole family would suffer through no fault of their own. I couldn’t accept that.
Thank you for your kind words!
I just heard about this site, this GetRichSlowly site,and found amazing gems of articles in it.
Nice take on how to care for your financial worries, I must say. I have read other solutions but this seems to be the best I could find among many. I haven’t thought about it before but it really seems like a good idea to create separate accounts with different banks. The harder to process, the harder it is to access.
A great medicine for impulsive spending! :)
Nice piece of content, Ellen. I’ve read this on the IM social networking site, Kingged.com where it has been shared. :)
Ingenious idea! I would say the most important takeaway is to setup a system that works best for you to win with money. Instead of setting up separate accounts with different banks, I choose to utilize my online bill pay to automatically pay 1/2 a bill on the 5th and the other 1/2 on the 20th. That way I never put myself in a position to spend bill money.
That’s a great idea! A different approach to solving the same problem.
I might have to steal that idea and incorporate it into my system.
Thanks!