The Waterline Method

The beginning of the year serves as a perfect time to begin getting your finances intact. If you’ve been following along with these posts, I recently covered how young professionals can start their financial journey off on the right foot by focusing on the basics of their cash flows. You can find that article here. 

Awesome, so now we know that monitoring our cash flows and having a cash reserve is something we should strive for. But how do we go about that? The main options when it comes to tracking our expenses are usually traditional budgeting, reverse budgeting, and what I call the waterline method, which I believe is incredibly forgiving, less time-consuming, and much less restrictive than the first two. 

Traditional Budgeting / Reverse Budgeting

So many people take time to build a budget, especially at the beginning of the year. They allow themselves a specific amount of money for both fixed and variable expenses. Using a reverse budgeting strategy, you would earmark a set amount to be saved or invested each month, as if it is an expense. However, the savings or investment would be fixed and is usually taken care of before anything else. If you have ever heard someone say, “Pay yourself first,” that is derived from reverse budgeting.

Each of these budgeting methods is fairly tedious and, in my opinion, they are slightly out of tune with the habits of a young professional. First off, I find these methods to be restrictive. You are taking a stab at what you “think” you should be spending on completely variable expenses such as Ubers, nights out, entertainment, and potentially even travel. This is incredibly hard! You’ve just begun your career, you may have just moved to a new city, and you want to have fun and enjoy yourself, but now you have an arbitrary metric limiting the amount of your paycheck that can be used for certain expenses.

This is not to say that young professionals should be dining out and clubbing every night in the name of their newfound financial windfall (a paycheck). It is to say that these forms of budgeting can bring a sense of doubt around your finances. You have worked incredibly hard to get where you are today, now you’re second-guessing the coffee you wanted to treat yourself to because it may not fall in line with your budget.

Waterline Method

Before I begin here: For those of you who think your financial advisor would ever judge the amount you’re spending every month, you’re wrong! We have seen it all. There is absolutely no shame in enjoying the fruits of your labor and living comfortably. I cannot recall one time when a client was ever shamed for their spending. Instead, we focus on other areas to increase their savings amount, such as earning more! This is huge for young professionals especially. Investing in yourself and your career can have a much higher ROI than traditional investing. 

Anyway, here we go. This is a method that we constantly recommend to clients. It is something that takes a few months; however, it is not nearly as restrictive as traditional or reverse budgeting. I truly believe this is the most hands-off approach to budgeting, allowing you to continue about your daily life without feeling contained to what an Excel sheet says you can spend on a sandwich for lunch this week.

Essentially, what it entails is having a waterline. 

Here is an example: I leave $2,000 in my checking account. This serves as my waterline. After the first month, I ended with $2,200. After my second month, I ended with $2,100. After the third month, I ended with $2,300. 

So, after three months, I had $300 accumulated in my checking account. Even though the balance decreased from Month 1 to Month 2, over the full 3 months I ended up with more than I started with. In financial planning, we like to look at the big picture and smooth things out over a longer timeframe, rather than let one month dictate what we’re spending or saving. This method allowed me to spend freely, and not monitor every transaction I made over the three months. I have now identified that I have the capacity to save on average $100 per month.

Instead of constraining my spending habits to arbitrary numbers that I came up with in an Excel sheet, I was able to naturally and comfortably see what amount of money I needed to make myself feel comfortable and I was even able to identify that I could save an additional $100 per month!

If I had ended up with $1,800 after the 3 months, I would have to take a closer look at my spending. At that point, I’ll have to ask myself; did I have any one-off events that were expensive, or am I living outside of what my paycheck can support?

In either case, the waterline method gives us freedom to continue living our lives, spend on what we enjoy, and ensure we do not feel constrained when it comes to our finances.

PS: Everyone has a different level of what makes them feel comfortable. You have to find a happy medium between being comfortable, spending freely, and saving for your long-term goals. All of personal finance is a balancing act, those who can find the happy medium are more likely to stay the course over long periods of time. 

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Have a more specific question or want to get your finances in order? Feel free to reach out to [email protected] for a free consultation!