Have you ever found yourself struggling to save money, even when you're earning enough to cover your expenses? Well, that's a common problem that many people face in their personal finances, and it's often because they're not budgeting for their true expenses. This is where Rule 2 comes in.
Rule 2 is all about setting money aside for true expenses in advance so that you're not caught off guard when they come up. It’s about reducing nasty financial surprises and increasing your ability to absorb them when they inevitably catch you by surprise. By planning ahead and budgeting for these types of expenses, you can avoid having to dip into your emergency fund or use credit cards to cover them.
This article part of the YNAB 4 Rules series. You can also check out my list of the best YNAB tutorials.
What Is The Second Rule Of YNAB?
The second rule of YNAB is, “Embrace Your True Expenses.” True expenses are expenses that you know are going to come up at some point, but they're not necessarily part of your regular monthly bills. For example, Christmas gifts, car repairs, or home maintenance. These expenses can be unpredictable or occur infrequently, so it’s easy to forget about them until you’re hit right in the face with an unexpected bill.
The Principle Behind YNAB Rule 2
The second rule of YNAB is based on the principle that you should treat all of your expenses like monthly expenses. When you treat all expenses like monthly expenses, you can allocate a specific amount of money to each category every month, reducing or eliminating peaks and valleys in your monthly spending. When you proactively set aside money for these expenses each month, you make it easier to handle them when they come due. Treating all expenses like monthly bills helps you avoid surprises and keeps you from having to scramble to find the funds to pay for unexpected expenses.
Types Of True Expenses
True expenses are another name for sinking funds, and they can be divided into two types: predictable and unpredictable.
Predictable True Expenses
You know when predictable true expenses are due, and you know how much they cost. Here are a few examples:
- Annual subscriptions like Amazon Prime, Costco Membership
- Seasonal items like holiday and birthday gifts
- Annual or semi-annual insurance premiums
Unpredictable True Expenses
You know that unpredictable expenses will happen…eventually. You don’t know when they will happen or how much they will cost, exactly, but you know for sure that they are coming. Here are a few examples of unpredictable true expenses:
- Car repairs
- Home repairs (my furnace unexpectedly broke down recently)
- Medical expenses
- Vet bills
Here are even more examples of true expense budget categories.
New budgeters will quickly learn that it is nearly impossible to anticipate every true expense when setting up a budget. In order to properly plan for and manage true expenses, it is important to regularly review your budget and adjust for changing needs. As you become more experienced in budgeting, you will find that your ability to plan for true expenses improves over time. You'll also become comfortable adding new ones to the budget as you discover them.
How To Implement Rule 2 In The YNAB Budgeting App
The YNAB App makes it easy to plan for true expenses by allowing users to create separate categories for each type of expense. This allows users to set aside a specified amount of money each month to cover their true expenses (you can do this automatically using a feature called targets), making it easier to absorb any financial surprises that may come up. Additionally, the app provides budgeters with powerful insights about their past spending. The longer you use YNAB, the more accurately you will be able to predict your future true expenses.
Step 1: Make A List Of All Your Expenses
List every expense you can think of along with its frequency, next due date, and amount. This may include subscriptions, memberships, insurance premiums, taxes, maintenance and repairs, medical bills, gifts, etc. Create categories for each of these expenses in YNAB.
Step 2: Set Targets For Every Budget Category
Setting targets for every category makes budgeting so quick and easy that anyone can do it. It automates the task of giving every dollar a job.
Remember, this is a one-time activity. Even though it can take a while (it takes me about 20 minutes in this from scratch with a new budgeting client), it will massively improve your budgeting experience. It will save you many hours each month.
Here is an in-depth demo of how to create targets for every category in your budget. The video is long because I wanted to be thorough. Once you've got the hang of it, feel free to skip ahead. I recommend watching at least the first 5 minutes and then from 22:49 to the end.
Targets in YNAB are flexible. It is perfectly fine to use different target types than the ones I use in the demo. Hopefully, watching me think through 30 categories provides inspiration for how you might handle your own targets. Remember, you can change targets at any time, so if you’re not sure which one to pick, don’t overthink it. A good budgeter makes adjustments over time as they gain insights into their spending needs.
As a general rule, you can use the "Needed For Spending" target type for predictable true expenses and the "Monthly Savings Builder" target type for unpredictable true expenses.
Step 3: Assign Every Dollar A Job
Now that you've created a target for every category in your budget , it's time to assign each dollar a job. This means that for every dollar you receive (whether from income or savings), you have identified the job it will do in your budget. This is because the YNAB budgeting app follows a zero based budgeting method. See my article YNAB Rule 1: Give Every Dollar A Job for detailed instructions.
Common Mistakes Following Rule 2
The two biggest mistakes people make when learning to embrace their true expenses are not adjusting their targets over time and not prioritizing true expenses over discretionary spending.
Not Adjusting Targets Over Time
Remember that your true expenses will change over time. As you get older, you may have new expenses such as medical bills or home maintenance costs. As your needs change with family members, new children, or pets coming and going, you'll discover new true expenses. Inevitably, you'll find yourself paying for something that doesn't fit into any of your existing budget categories. When this happens, don't panic! Just add the category, set a target for it, fund it by following YNAB Rule 3: Roll With The Punches, and move on. It's important to update your targets regularly in order to adjust for these changes.
Not Prioritizing True Expenses Over Discretionary Spending
When you follow rule 2 for any period of time, you start to have more money. The longer you follow rule 2, the more money you have. With greater amounts of money comes greater responsibility! You'll be tempted to spend the money from your insurance premium or Christmas gift category in July because, hey, you probably won't need it until November, right?
The key is to prioritize the true expenses you identified in step 1 above and make sure they are being covered first before any discretionary spending. Once your true expenses are taken care of, you can start thinking about how to use the left over money for fun stuff.
Conclusion: Embracing Your True Expenses Is the Key To Breaking The Paycheck To Paycheck Cycle
Following these steps will help ensure that your budget accurately reflects your true expenses. As you adequately prepare for these expenses, your financial security will begin to skyrocket, as will your bank account balance. While Rule 1 provides clarity, Rule 2 starts to provide comfort and security.