About a year ago I was at Smashburger with my friend Kirby. After ordering, Kirby pulled out his iPhone and entered something into it. Intrigued, I asked him what he was doing. “YNABing lunch,” he said.

“What’s YNAB?” I asked. That simple question led to me using a tool that’s had a huge impact on my life, my finances, and even my marriage.

You Need A Budget (YNAB) is unlike any other budgeting/financial tool I’ve used (and I’ve tried a bunch). From the time I started my first business in high school, I was an avid user of Quicken and Quickbooks. When Mint came out, I jettisoned Quicken and moved my financial life online. Finding myself deep in debt 10 years ago, I read Dave Ramsey’s Financial Peace, the precursor to The Total Money Makeover, which led to a decade of attempts to use the cash envelope system. But regardless of the tools, nothing helped Amy and I get on the same page about our finances and modify our behavior to actually live consistently on less than I make, until YNAB. Now, a year into the YNAB journey, we’re finally discovering the financial peace that Ramsey promised us a decade ago.

Amy and I loved the idea of Dave Ramsey’s envelope system; we even facilitated a Financial Peace University group. But because it’s built on carrying cash around in envelopes, we found it really challenging to implement in everyday life. As an example, Amy might call me at work and ask me to pick up something at the store. Chances are I would not have the “Groceries” envelope with me (it was inevitably in her purse). So I would use my “Mad Money” cash to buy milk. Then when I got home I’d try to reimburse myself out of the “Groceries” envelope, but I wouldn’t have the right change. Or even worse were the times that I had no money with me so I’d buy the $4 item on my debit card. Then what was I supposed to do? Take $4 out of the envelope and go deposit it in the bank?

I find it incredibly inconvenient in this day and age to use cash for everything. However, pulling cash out of an envelope did modify our behavior. Seeing the cash go away really helped bring clarity to our spending decisions, but we never managed to go more than a few weeks (or maybe a month or two) before we fell off the bandwagon. Another downside of the cash envelope and paper budget system was we continually felt like failures. Every month we screwed something up, and we never managed to get ahead. Clearly, The Total Money Makeover has worked for many thousands of people. We just weren’t disciplined enough to implement it properly, so it didn’t work for us.

Back to Smashburger. Kirby went on and on about how great YNAB was and how he and his wife Steph had gotten out of debt using the system. He explained how with YNAB it didn’t matter what payment method you used, how they met every few weeks for a “budget meeting,” and how they were able to “whack a mole” (more on that later) if they needed to overspend in a category. That afternoon I visited the YNAB website and we started our YNAB journey.

The YNAB system is built on four rules: Give Every Dollar a Job, Save for a Rainy Day, Role with the Punches, and Live on Last Month’s Income.

Rule One: Give Every Dollar a Job

In the past when I wanted to buy something I’d make the decision based on my bank balance. If I’d just received a paycheck and seemingly had plenty of money, I’d feel wealthy and be much more liberal with my spending. If it was a few days until my next check and we were running out of money, I’d hold back because the bank balance said “no.” With YNAB we act very differently. Give Every Dollar a Job is the process of assigning all income to budget categories. True YNABers don’t assign any money to categories until it’s actually in the bank. However, since I know exactly how much I get paid each month, I do break this rule and budget the entire month’s income at the beginning of the month. However, I can definitely see that waiting until money is in the bank before budgeting it would be the best way for someone with an unpredictable income to stay out of trouble.

Amy and I have our YNAB budget broken up into several primary categories:

• Giving (this has two subcategories: Monthly Giving and Giving Fund)
• Everyday Expenses (this has subcategories that we spend out of like Groceries, Fuel, Kids’ Allowance and Entertainment)
• Monthly Bills (this has subcategories that we don’t have as much control over like Mortgage, Utilities, and Insurance)
• Rainy Day Funds (more on this in Rule #2 below, but it has subcategories like Car Repairs, Home Repairs, Birthdays and Christmas)
• Savings Goals (Vacation and Car Replacement)
• Pre YNAB Debt (this is where all the credit cards we’re still paying off are)

Budget categories work similarly to the cash envelope system when it comes to modifying behavior. Say a friend invites me to a movie. Rather than looking at my bank balance to make that decision, now I look on my phone to see how much money we have left this month in the Entertainment category. My bank balance doesn’t matter (it’s actually pretty high most of the time thanks to rule #2, but that money isn’t available to watch movies with).

Rule Two: Save for a Rainy Day

This may be my favorite of the rules because it takes the surprises (the bad kind) out of our finances. It used to be that when I needed to put new tires on a car I had to suddenly come up with an extra $600. Now we just budget a certain amount every month for car maintenance (a subcategory in the Rainy Day Funds section of our budget). And when I buy new wipers or get an oil change or need a new transmission, it comes out of this fund. The money’s already there.

The same thing is true for quarterly tax payments or homeowners association dues. I used to get surprised every time my car registration was due (I know, it happens every year, right). Now I just take the annual amount due, divide it by 12 and budget that on a monthly basis in its own Rainy Day Fund, and the funds are there when we need them.

In Dave Ramsey’s system you have an emergency fund for unplanned crises. With YNAB, you plan for things that others consider emergencies.

Rule Three: Roll with the Punches

I like to think of our budget as a living, breathing document. Rather than assuming that we can predict the future and know exactly how we’ll spend money next month, we do our best to plan, but adjust as needed.

When I went over budget in The Total Money Makeover system, I felt like a failure. With YNAB if you go over in a category, it’s not a big deal, as long as you pull that money from another category in your budget. They call this rolling with the punches, or Whack A Mole (because you get rid of red areas in your budget by whacking the money out of another area of the budget). It’s made living in a budget achievable for us.

Rule Four: Live on Last Month’s Income

Rather than having a big emergency fund, the YNAB system encourages you to get to the place where you’re living on last month’s income. When you enter income into YNAB, it lets you choose to apply it to this month’s or next month’s budget. Over time, as you implement the system and build up your “Buffer” category in your Rainy Day Funds, you’ll get to where you can apply more and more of this month’s income to next month. The goal is to have this month’s budget entirely funded by last month’s income. You have all the money you need for a month at the beginning of the month. Once you’re there, you don’t ever have to think about your bank balance (with the Rainy Day Funds in place, it’ll actually be really high).

One question I am asked by almost everyone I tell about YNAB is, “Does YNAB auto-import transactions from my bank?” My answer is that even if it did do it well (even Mint has trouble with this), you wouldn’t want it to. The magic of the cash envelope system (for all its weaknesses) is that it does help you modify behavior because you see the cash going away (uh oh, I’ve only got $3 left in the Starbucks envelope and there’s still a week left in the month). I’ve found that the YNAB categories have the same magical effect because every time you manually enter a transaction on your phone you see exactly how much money you have left in that category.

Auto-importing would make YNAB like Mint, and the problem with Mint is it’s like using a weight loss app that automatically keeps track of everything you eat and sends you a report at the end of the month telling you exactly why you haven’t lost any weight. To lose weight you need to make decisions about what to eat today, not wait until the end of the month to find out how many calories you’ve consumed. Mint is great at telling you what’s happened with your finances. But in my experience it doesn’t do a good job of changing how you spend your money. There’s power in connecting the action to the consequence in real time (more on that in a future post).

The YNAB app does use geolocation to learn where you spend money. When you pull out your smartphone at Starbucks and enter the $5 latte into the app, it knows where you are and which category you use to track caffeine in your budget. It’s as simple as clicking Add a Transaction, entering the amount, and confirming it got the other stuff right. Then you hit Save and it shows the updated balance for that category.

YNAB isn’t perfect. It should be completely cloud based, but at the moment its central nervous system is a piece of software that runs on your Mac or PC. You use the desktop software to plan your budget and then it syncs to the YNAB app on your smartphone via Dropbox. Rumor has it that they’re working on a fully web-based version . . . I’ll be the first to sign up.

The Duct Tape Test: Will it stick?

A year into using YNAB we’ve paid off more than $20,000 in debt, we are no longer living paycheck to paycheck, and the money to put snow tires on Amy’s van this week came out of our “Car Maintenance” category rather than our emergency fund (or worse, a credit card). This is where what Tim Ferriss calls the Duct Tape Test comes in. Will you actually keep doing this? It turns out that the best financial plan is the one you’ll actually follow. YNAB has been that for us, and we’ve finally found financial peace, too.

Ready to give YNAB a try? Use this link and you’ll get a 34-day free trial and save $6. I’ll get $6 too, which will go straight into my “Spending” category :).