Living on Last Month’s Income

Will writes in:

During the winter Steam sale I picked up You Need a Budget because I remembered you recommending it a few times. I’ve started using it and it’s pretty good, but I wanted to ask you about their four rules of cash flow especially the one about living on last month’s income. One, is that really necessary, and two, how do you get to that point?

I actually wrote about the “four rules of cash flow” about a year ago. Here they are again, for those who missed it:

Rule 1: GIVE EVERY DOLLAR A JOB.
Rule 2: SAVE FOR A RAINY DAY.
Rule 3: ROLL WITH THE PUNCHES.
Rule 4: LEARN TO LIVE ON LAST MONTH’S INCOME.

Will’s questions center on the last rule – learn to live on last month’s income.

The idea is simple. When you get your paycheck, you simply set it aside for one month before you begin to use it. If you’re at the point that you can do this, then that pile of paychecks waiting for you becomes a one month buffer against whatever might happen in your life, like a job loss or a career shift.

Is it really necessary?

Is it necessary to live on last month’s income? No.

Is it useful to live on last month’s income? Sure.

Basically, living on last month’s income is sort of a guaranteed emergency fund. By having that money securely in hand, you know that whatever happens, you will be able to financially survive for at least one month. Of course, it makes sense to have an additional emergency savings on top of that – living on last month’s income should be a last-ditch emergency buffer.

As with a normal emergency fund (which is something I consider essential), living on last month’s income simply steadies the uncertainties of life. You don’t know what tomorrow will bring, but it’s pretty certain that having cash on hand will make whatever happens substantially easier than it might otherwise be. There’s no need to sink into debt because of the bumps that life throws at us.

You can achieve much the same thing with a normal emergency fund – here’s my guide to doing just that. The process of living on last month’s paycheck just makes it easier to grasp.

How do you get there?

If you already have an emergency fund, it’s very easy. Just live out of your emergency fund for a month and put those paychecks aside.

The process of moving from a paycheck-to-paycheck life to living on last month’s pay is a bit trickier, but the steps are almost exactly the same as building an emergency fund.

First, you need to build some breathing room. Just look throughout your life for simple steps you can take to save money, particularly when that change easily leads to lasting savings.

For starters, look at your monthly, quarterly, and annual bills. Are there ones that you can easily cut back on? Are there some you can eliminate entirely without reducing your quality of life? You should shop around for better rates on auto insurance, home insurance, life insurance, cellular plans, cable or satellite television, internet service, and so on. If you can trim some money off of your regular bills, you’re doing great.

Another valuable part of the equation is to start “snowflaking.” Snowflaking simply means to look for simple ways to avoid spending in your day-to-day life by making a choice in the moment to keep that wallet in your pocket. If you’d normally stop at Starbucks for a cup of coffee and you choose not to, you just “snowflake’d” $5. That doesn’t mean you’re giving up your coffee – it just means you kept $5 in your wallet.

While you’re doing that, don’t let your spending in other areas increase. You need to hold things steady. It’s tempting to spend more when you see cash sitting in your checking account, but that can be a real mistake. If you find this difficult, move some money from your checking account into a savings account that you can’t easily access from an ATM card and just forget about that account for now. I use a separate bank for this very purpose – to keep some of my liquid cash out of sight and thus out of mind.

If you do this consistently, you’re going to be spending less than you bring in. Let that build up over a few months until you’ve reached a point where, when a new check comes in, you already have more than that in your account. When you’ve reached that point, you’re living on your previous paycheck, not your current one.

Once you reach this point, I personally recommend having paychecks deposited into a separate account, then transferring money over to your main checking account once a month. The larger the buffer you allow to build up in that separate account, the more secure you are.

In the end, this is simply an alternative way of looking at an emergency fund. Regardless of whether you try this approach or another approach when assembling one, an emergency fund is a vital personal finance tool.

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