Introduction: What’s Wrong with Other Budgets?
Most current budgeting systems or popular methods fall short in one or more of the following areas.
These old-school budgets:
- Focus too much on tracking past expenses rather than planning for future ones
- Don’t account for irregular/infrequent expenses that seem like “emergencies” but are actually fully predictable
- Forget to consider the human psychology of spending and temptation
- Overlook the importance of liquidity funds (aka emergency funds), especially the need to replenish a fund once it’s been used for an infrequent expense
- Don’t truly show the huge tradeoffs between current spending and long-term goal achievement
The Sage Habits 4P Budget addresses these shortcomings by focusing on four distinct pillars that can help bring clarity, purpose, and control to your finances that you can confidently achieve your goals. With the 4P budget, you’ll actually find that your budget is liberating when it lets you spend on fun stuff, both now and in the future, without worry or guilt.
Here are the four pillars of the 4P budget that we’ll cover in depth:
- Prepare for the unexpected with safety nets to give you a soft landing when disaster strikes.
- Predict necessary spending and allocate monthly amounts, even if the event occurs rarely.
- Provide for the far future by saving now and letting it compound.
- Prevent overspending in discretionary categories with the amount leftover after you’ve fully funded the previous three pillars.
I’m pretty sure that the car you drive has four wheels, and I’m even more sure that each one is important. Lose even a single wheel and you can’t safely go places! Likewise, you can’t eliminate a pillar of the 4P budget and expect it to hold up. If you just focus on predicting and preventing, for example, you’ll forget about long-term goals and won’t be prepared for unpredictable calamities, like a job loss.
Article Contents:
Pillar 1: Prepare
Prepare for the unexpected by building safety nets
Just starting out? Begin with the Prepare pillar by building a series of safety nets. They don’t even have to be monetary when you’re starting out, but in essence a safety net is short-term escape plan for stuff outside your normal monthly budget. Once your budget matures, you’ll be able to save for the long-term as well. But for now, let’s focus on safety nets—what they are, and how to build your own.
What’s a Financial Safety Net?
If you’ve ever seen a trapeze act at a circus or workers repairing a tall structure, chances are they are using a safety net. The trapeze artists need it to catch people if they mis-time a swing, and the construction workers use their nets to catch falling tools or debris. These nets can save lives when something unexpected happens.
In the same way, a financial safety net can save you or those you care about. A properly prepared net provides a cushion when you unexpectedly run into something your monthly budget just can’t cover. Life is unpredictable, so you need to build a net of your own, starting right now**.**
Types of Safety Nets and Where to Start
The best type of financial safety net is a large pile of cash or another very “liquid” asset. If you already have that, keep reading to to see if you have a big enough pile.
If you don’t have that plethora of pennies yet, or maybe you have a negative cash position (debt), let’s figure out how you can build a safety net, step by step.
Think of a safety net as living in one of 4 quadrants of a 2-by-2 matrix, like in the graphic below.
Quadrant 1 is healthy, but not really sustainable; you shouldn’t stay here in the long-term. If you do, you risk your net decaying and becoming unhealthy as well as being unsustainable.
Quadrant 2 is up and to the right and represents a healthy, sustainable, long-term solution for your safety net. This is where you want to be for your entire adult life.
Quadrant 3 is unhealthy, yet people can stay somehow manage to stay here for years as they slide deeper into debt and misery. Eventually this quadrant naturally leads to Quadrant 4 if you’re not actively working to move to a healthier quadrant.
Quadrant 4 is also unhealthy and provides only short-term relief. This may be “rock-bottom” for you, which should be terrifying enough to compel you to immediate action. It’s time to laser-focus 100% of your energy on moving to a healthy quadrant.
Let’s move on to the other pillars for now, but when you’re ready to build your safety net, read more about implementing the Prepare pillar.
Pillar 2: Predict
Set aside monthly amounts for predictable expenses, even if they are years away
Most people start thinking about their budget by looking at their regular monthly bills. That’s great! It’s the perfect place to start. We’ll talk about how much to spend on each of these areas in a separate article, but for now the main benefit of the 4P budget is that the Predict pillar forces you to do the hard work of finding out exactly how much to set aside for budget items you can reasonably anticipate, even when those expenses are neither monthly nor regular.
Start Predicting Regular Expenses Here
Here are some examples of monthly items you can predict easily:
- Housing, meaning mortgage or rent payments, including mandatory things like insurance and taxes
- Utilities like electricity/gas, water, internet, cellphones
- Groceries and food essentials, not extravagance
- Transportation, like a car payment, gasoline, bus/rail passes
- Health Insurance premiums or routine medical expenses, like prescriptions
- Debt payments on student loans, credit cards, personal loans
- Generosity, the tithe or offerings to your church, missions organizations, charities/non-profits
Some mandatory bills like rent or mortgage payments are easy because they are fixed amounts and paid monthly. What about renter’s insurance or life insurance, which could be only once a year? Or variable amounts that require more history and math to predict? If you don’t account for those infrequent and variable expenses, you may be surprised once a year by a big bill that will ruin that month’s budget. Let’s cover those types of bills next.
This Infrequent Stuff Is Harder to Predict
Here are some things you can are more difficult to predict, but totally doable based on previous spending:
- Vehicle maintenance such as oil changes, tire replacements, scheduled service, auto insurance
- Medical expenses including annual check-ups, anticipated treatments, dental procedures, etc. Does your kid need braces in 2 years? Put it here.
- Seasonal expenses like lawn care, winter outdoor maintenance, back-to-school supplies
- Annual fees such as annual memberships, rental insurance, property taxes, or other stuff you get surprised by once a year
- Professional services, tax preparation, lawyers, financial planners like me
Annual committed expenses take just a little more work than true monthly bills, since you just divide by 12 and set aside that twelfth each month. So the fixed infrequent expenses are fairly easy, but the infrequent and variable expenses will require you to track closely and build up funds for those in an accumulating category.
Expenses Occurring Less Than Once a Year or Randomly
But what about things where there’s no schedule or contract? That’s where the Predict pillar really shines!
If you’ve been tracking expenses for a few years, or even if you can get your old credit card and bank statements, now is the time to be a detective🕵️.
You’re looking for things that happen less than once a year or are not on any kind of schedule, stuff that’s hard to predict:
- “Surprise” home repair that aren’t really surprises (since stuff wears out) such as new appliances, a new roof, new windows, plumbing repairs
- Major car repair or replacement, especially if your car is out of warranty or has more than 100k miles
- Major medical expenses like a broken leg, hospital stay, or surgery
- Weather-related damage that’s unpredictable, but somewhat foreseeable if you live in a flood/hail/hurricane zone and can see what’s happened in the past
Since these aren’t on any kind of schedule, how do you budget for them? You’ll need took far ahead and figure out a lifespan for things that you know will break down, like a furnace, refrigerator, or car. As an example, Better Homes & Gardens lists the lifespan of a washing machine as 7 to 15 years, so pick a number within that range, like 11 years. Estimate how much a new machine will cost in 11 years (accounting for inflation) and then start setting aside that amount monthly.
What if your machine is already a bit older and breaks just a few years from now? Since you’ll be saving for all these types of less-frequent expenses in budget category like “Appliance Replacements” or “Major Car Repair”, you don’t need to worry about individual items. You’ll pool the risk of any particular expense with all the others so that, over time, you’ll have all major expenses covered.
If you look above, you’ll note that virtually all of these less-than-annual items are mandatory expenses. The Predict pillar shines for these true needs. In contrast, we’ll cover “wants” in the Prevent pillar, which helps you prevent overspending on discretionary items. But first, we need to set aside money for far future goals in the Provide pillar, below.
Pillar 3: Provide
Save now to provide for the far future with compounded gains
With your safety net from the Prepare pillar established and your Predict pillar’s necessary bills taken care of, it’s time to allocate part of your income each month into the Provide pillar. “Provide” funds will be reserved exclusively for far-future goals. Since you’ll leave these investments alone for two, three, or even four decades, you’ll likely see your original contributions grow by 10x, hopefully much more!
The Big Rocks First
Here’s a quick overview of the top three priorities:
- Save for a house down payment if you’re renting.
- Save in tax-advantaged accounts for retirement and kids’ college using a 401(k), IRA, HSA or 529 plan.
- Save up to pay for large purchases such as “toys and trips”.
If you want to dig further, we have a much more in-depth ideal order of savings article that will go into the nuance needed for variety of situations. It covers both the math and the psychology of how to save while feeling great about doing so.
For a simplified consideration, just work on the first two priorities—housing and retirement—when you’re in your 20s, and then work on all three priorities as you enter your 30s.
Pillar 4: Prevent
Prevent overspending by sacrificing what you want now for what you want most
The “Prevent” pillar focuses on preventing overspending by controlling the areas where you might be tempted to make purchases you can’t afford. Specifically, it’s here that you get to learn the discipline of saying “no” to urgent things that are less important to you so that you can say a resounding, guilt-free “yes!” to things that are more important to you down the road. It’s primarily about the psychology of delayed gratification: knowing yourself and setting up systems and tools to hold yourself accountable so that you’ll stay on track to achieve your most important goals, both now and in the future.
Common Categories in the Prevent Pillar
- Restaurants (dining out, takeout meals, food delivery)
- Entertainment (streaming services, movies, concerts)
- Technology & Digital Items (phones, tablets, wearables, ebooks, gadgets of all kinds you may “need” but can much too easily overspend on)
- Clothing (adults, kids, shoes, seasonal)
- Home Decor (pretty stuff that’s not really needed—nice but not essential)
- Subscriptions (deciding whether you want them or not—then you’ll need to predict the annual cash flows with monthly allocations)
- Hobbies and Recreation (sports, hunting, collectibles, crafts, “toys”, travel or vacations)
- Kids (activities, trips, toys, games/music)
- Impulse purchases (especially large items or frequent, habitual purchases)
OK, with this brief overview of all the pillars covered, let’s look at how to actually implement the 4P budget in your household.
Using the 4P Budget in Your Life
Step 1: Track your current spending and income
- Look at the total amount you’ve earned in the last 2-3 months (go longer if your income is moderately variable each month).
- Total up all your expenses over that same time period. Spreadsheets are handy for this, but if your bank portal lets you do categorization, you can probably use it, at least for income (which goes to your checking) and expenses (on a debit/credit card).
- Now subtract expenses from income to calculate the difference. Is it a surplus (positive) or a deficit (negative)?
- If you’ve got a surplus of income, that’s great, let’s go move on to step 2, below.
- If you’ve got a deficit of income in every month or even just a few months, meaning you are spending more than you make and are taking out additional loans or increasing your credit cards balances, you will need to work through our “Stop the bleeding” plan before you can adopt the rest of the 4P budget (but come back here when you’re out of imminent danger).
Step 2: Evaluate your current safety nets and build better ones
Your goal here is to eventually end up in safety net “Quadrant 2” with a healthy, sustainable liquidity fund. Your first task is to figure which quadrant you’re in currently, then we have specific guidance on how to make progress in building better, healthier safety nets. Learn more in the safety net deep-dive.
Step 3: Learn how to accurately predict future expenses
With a safety net built, even if it’s not yet 100% healthy or sustainable, you should focus on the next pillar, Predict. To implement this pillar effectively:
- Gather up 12-18 months of past expenses to identify patterns. You looked at just a few months of previous expenses and income in Step 1, but you’ll need to go back much further for expenses to accurately predict future ones. Credit card companies and banks should give you access to several years of statements, and some even provide handy year-end summaries with high detail.
- Only look at expenses that cost more than 2 hours of what you make at work. If you make $20 per hour, that’s $40. So, for this level of income, find necessary expenses that you can reasonably predict that cost more than $40. If you make $50/hour, only look at expenses that are $100 or more. Pick the right level of detail for your particular situation. Your bank might have a filter that lets you specify a particular dollar amount, or just download everything and filter in Excel/Google Sheets.
- From these larger expenses you found in the previous step, separate out just the mandatory expenses where you’re not tempted to overspend, then try to determine their frequency.
- Fixed monthly expenses are easy, or if something happens more than once per month, total up all smaller payments to get a full month.
- Expenses that vary each month or occur less than monthly need to be added up for a full 12 months and averaged out over the year to account for seasonality.
- Assign logical category titles to each of these fixed or variable groups—you can use our list of Predict vs. Prevent categories or make your own.
- Once you have an average monthly amount for the previous 12 months for each category, be sure to increase your allocation to account for price increases you’re expecting this year, especially on things like gasoline or food that tend to have large price swings.
- You don’t want to be constantly underwater in these categories during your first year of budgeting, so try to anticipate how much you’ll be spending a year from now and work backwards from that amount.
- Certain categories, like homeowners’ insurance, have recently risen much more quickly than inflation, so you won’t be able to predict every increase, but for things like utilities that have a smoother curve, you’ll be able to estimate more accurately.
- Finally, use automated bill pay services to make sure each of these items is paid on time, and sweep the entire amount you’ve budgeted for the Predict pillar into a high-yield savings account so that you can safeguard the amounts you’ve set aside for irregular bills.
- You are working toward funding all of next month’s predictable allocations (remember you’re saving a monthly amount for all the year’s expenses, regardless of when they occur) from this month’s paycheck and keep that money in savings, only moving it back to checking as needed to pay bills such as utilities or credit cards from your checking account.
- If you can pay specific fixed expenses (like your mortgage) easily from your savings account, then you can skip the transfer back into your checking; also, many employers allow you to set up a direct deposit into savings, so try splitting your paycheck between your checking and multiple savings accounts, as needed.
Step 4: Begin providing, even if it’s ten bucks a month
When you’re in your twenties or thirties, saving for big goals like retirement or kids’ college seems ridiculous. Those events are so far away! However, you’ll be missing out what what Einstein is often attributed as calling (probably falsely) the 8th wonder of the world: compound interest, or “the most powerful force in the universe.”
We don’t really know if the iconic E = mc² genius cared a whit about money or compounding, but you can see why it matters—it’s truly a miracle when your money makes more money for you. How does it work? It’s very counter-intuitive to see such exponential gains due to interest that itself earns interest. But the key is T-I-M-E. Ideally you should start young, but even if you’re no longer young, you can still let your money grow for decades if you start N-O-W.
- The best place to start is with an employer plan, specifically an HSA or 401(k). These are the best, most reliable, most tax-advantaged vehicles for long-term savings, and they often come with some level of employer matching opportunity.
- HSA contributions from your employer are usually free money. We do a lot of advice on the nuance behind picking the best health insurance plan, but the bottom line is that if you’re basically healthy you should try to max out your HSA contributions and then not touch that money, even for medical expenses—just let it grow for the long term. After 65 you can withdraw the money without penalty, and although the contributions were tax-free, even the withdrawals will be tax-free if you use them on health expenses (which you’ll presumably have a lot of in your final years).
- 401(k) contributions from your employer usually require a match from you, so make whatever current sacrifices you need to make that will allow you to get that full match. Unlike the HSA, which usually doesn’t require you to contribute to get the company’s contribution, the 401(k) money from your company almost always forces you to to have skin in the game via regular paycheck deductions.
- If you want to learn more about retirement plans of all kinds, check out our ultimate guide to retirement plans
- If you don’t have an employer plan, you can still contribute to an individual retirement account (IRA, either Traditional or Roth). The word individual means that you can open the plan through a brokerage, bank or credit union, separate from your employer.
- Traditional IRAs allow you to make tax-free contributions, with tax on the withdrawals during retirement. The income limits for eligibility of having your contributions tax-free are pretty low if your employer already makes retirement plan option, such as a 401(k) or 403(b0), available to you.
- Roth IRAs allow you to make contributions after you pay current income taxes, but then you get tax-free withdrawals during retirement. The income limits for eligibility are more generous because there’s no test to see if you have a retirement plan at work.
- Both types of IRA allow your earnings to grow tax-deferred, meaning that any dividends or capital gains can compound and won’t get taxed until you make a withdrawal during retirement, which is defined as age 59 1/2 .
- If you have very young kids, consider starting a 529 plan and asking for contributions from older relatives like parents, grandparents, even aunts and uncles.
- If your kids are at least 10 years away (preferably 15) from college, there is enough time horizon to put funds into date-of-college mutual funds that could double those early contributions by the time your kids enroll.
- You can save into 529 plans even if you don’t have kids, but you’ll need to use them for qualified education expenses to a designated beneficiary eventually, not your own retirement; if you have siblings with kids, consider funding an account of your own that you can later designate toward their kids if you end up not having any college-bound offspring of your own.
- As a general rule, I de-prioritize 529 plans unless you have fully funded all your retirement options or the state where you live/work (pay taxes) has a really awesome tax benefit, like Indiana’s 20% credit.
Step 5: Strategies for preventing overspending
There’s a reason that this is the final pillar! Ideally you will have fully funded the previous three pillars in steps 2-4 and can’t easily overspend on the Prevent pillar categories because the money is already spoken for.
Here’s how this strategy works in practice:
- Fund the three previous pillars into accounts you won’t be tempted to touch
- When you’re ready to use the leftover funds for the Prevent pillar, set specific spending limits for each category in a budgeting program
- Then, here’s the key: check your remaining amounts before you spend out of that category
These short bullet points are just a quick intro to the lifelong discipline of spending less than you earn. To learn more, whether you use our 4P budget or another popular budget framework, here’s an in-depth look at how to actually stick to your budget and achieve your real financial goals.