Reverse Budgeting: The Easiest Way to Save and Spend
When it comes to wealth building, and habits in general, you want to establish a structure that’s going to keep you as consistent as possible. This is so you can reduce the friction, or push back, of carrying out different actions necessary for you to thrive within your personal finances. Budgeting is no different. There are many different views around budgeting but I want to talk about the easiest way to budget by saving for your top priorities first.
Insert the reverse budget.
What is Reverse Budgeting?
Reverse budgeting, also known as "paying yourself first", has become popular budgeting option due to its time-friendly, simplistic, & guilt-free approach.
Reverse budgeting involves funding, ideally via automation, the most important items first from your income and then living off what’s left.
These goals could be saving for retirement, a home, a car, travel, saving without a specific goal (saving just to save), or virtually any other goal that you have.
By saving first, you can have the peace of mind knowing the important things are being saved for each month AND you can enjoy what’s left over without guilt.
What Does Reverse Budgeting Look Like?
A great thing about Reverse Budgeting is that it’s extremely easy to set up and easy to tweak later on. But how do I implement one? Here are the steps.
Also, there’s an example down below.
Step 1: Determine Your Saving Rate
You’ll first want to determine how much you want to be saving, or “paying yourself first”, in aggregate for your retirement and other goals.
Additionally, it’s always best to apply saving rates to your gross income to ensure you’re saving enough. Basing saving on take home pay can drastically reduce your accumulation due to taxes and deductions.
Let’s assume you decide on saving 25% of your gross income: 15% towards retirement and 10% towards other goals.
If you earn $150,000 per year, then this would equate to saving approximately $37,500 with $22,500 going towards retirement and $15,000 going towards your other goals.
Step 2: Automate Your Saving
Once you’ve decided your total savings rate then you need to automate the amounts so it happens each month without you having to do anything.
If you have a 401(k) or retirement plan through work then you simply need to login and update your contribution percentage.
If you’re a high income earner then you’ll likely max out your 401(k) at some point while still needing to save additional money for retirement. If this happens then you’ll need to look at a taxable brokerage account or possibly doing a backdoor Roth IRA.
All other goals can be saved into a taxable brokerage or a high-yield savings account, via automatic transfers, depending on the time frame that you’ll need the funds and the risk you’re willing to subject those funds to.
Step 3: Automate Your Necessary and Fixed Bills
Once you’ve automated all of your saving, the next thing you need to do is automate your necessary and fixed bills.
Start with your high priority bills such as debt payments, rent/mortgage, food, transportation, etc.
You can self-impose “sub-budgets” with these funds to give yourself structure and keep you somewhat reasonable.
This could look like:
75% towards needs
15% towards debt
10% towards wants.
However, it isn’t necessary. But if you do decide to do this, then setting up separate checking accounts could be an easy way to keep funds separate.
It can be useful to automate the payment of all your bills and/or fixed expenses to a specific account or have food and groceries all come from an individual account. This can create convenience and give you better idea of how to plan for the remaining month.
You pretty much have a lot of flexibility on how you can structure this.
My only word of caution is that you need to be careful if you use credit cards for your living expenses.
You want to make sure they get paid off each month and that you don’t get into a habit of spending more on them than you have available in your checking account(s). Put another way, you don’t want to spend more than you have to live off of because credit has made it possible.
Step 4: Live On What’s Left
Finally, what’s left is yours to spend as you please.
The only real rule from here on out is that you have to live on what’s left until your next paycheck. This is wealthy way to “live paycheck to paycheck”.
Step 5: Monitor and Reevaluate
Finally, the last step is to periodically monitor your reverse budget and reevaluate. As life changes you can also come back and update your budget.
Reevaluating your process and budget can easily be done on a monthly basis but can also be done quarterly or semi-annually.
Some reasons you may want to reevaluate your reverse budget:
You get a raise and want to increase your savings rate
You pay off some debt and now have extra cash flow
You realize you can be saving more because you aren’t spending as much as you thought
Your living expenses change drastically
You get married
Again, when monitoring you should always look for ways to create automation and simplicity.
Why Reverse Budgeting Works
Easy to Maintain and Be Consistent With
I always tell people to pursue tools or routes they’ll be most consistent with. This is no different. This method is extremely easy to be consistent with because once you have everything set up, and automated, it requires little maintenance and attention.
It keeps running and doing its thing while you live life and focus on more important things throughout your days, weeks, months, and years.
Tracking Expenses Isn’t Necessary
One thing that trips people up often with traditional “budgeting” is tracking expenses. In the more traditional zero-based budgeting method tracking expenses is more necessary but it’s not with reverse budgeting.
Since you’re saving first and only spending what’s left, tracking expenses is unnecessary. This helps save time and empower you to spend money in a way that you see fit as long as your stay within your bounds.
Note: you can still track your spending under this method if you’re interested in spending patterns, spending history, or spending audits.
Shifts Focus to the Most Important Areas
Perhaps the one of the biggest reasons this works is that it shifts the focus to the most important areas that will move the needle within your finances. Too many people spend too much time prioritizing spending and thinking about what expenses to cut rather than simply starting with saving and living on the rest.
Then again you have to WANT to save and pay yourself first for this method to actually work for you.
I hope this overview has been valuable to you. As with everything in personal finance, this doesn’t have to be black or white. Feel free to have fun customizing what reverse budgeting can look like for you. The most important thing is that you’re “paying yourself first” and living off what’s left. Have fun with the journey!
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