As the world navigates economic uncertainties and rising inflation rates, Americans adjust their spending habits and budget more than ever.
When done properly, budgeting can help you take control of your finances. Unfortunately, the rigidity of traditional budgeting can hinder some people from incorporating this powerful finance tool into their lives. For some, it can be restrictive and cumbersome to track every expense and manage what’s left. Luckily, there’s an alternative to this traditional budgeting system—the reverse budgeting method.
The key to successfully managing your finances is finding out what works best for your unique situation. This guide introduces the reverse budgeting method and how to use it to reach your financial goals.
What Is Reverse Budgeting?
Reverse budgeting is also referred to as the pay-yourself-first method. In this budgeting system, you pay yourself first to fund your savings, investments, and other financial goals. Then, you use what’s left to take care of your necessities and other expenses.
How different is the pay-yourself-first method from traditional budgeting? In traditional budgeting, you track your income and expenses, and saving comes as an afterthought. Reverse budgeting is the opposite: It prioritizes your savings and investments over anything else, and you are free to spend what’s left.
Unfortunately, most Americans are struggling to build their savings. Studies indicate that 56% of Americans can’t cover a $1000 emergency expense. The reverse budgeting method can help people who aim to build their savings account, invest their hard-earned money, or create a solid emergency fund. By putting your financial goals first, you focus on the big picture and reduce the risk of impulsive spending.
How to Use the Reverse Budgeting Method to Reach Your Financial Goals
If you want to try the reverse budgeting method, we’ve got you covered. Here are five actionable steps you can do today to get started.
1. Identify Your Financial Goals
The main goal of reverse budgeting is to pay yourself first, meaning you’ll intentionally put money aside to achieve your financial goals. Identifying your goals early on can help you stay motivated in the long run and reduce the risk of spending the money you intend to save.
If you’re new to saving, consider building your emergency fund as your first goal. Goals can vary depending on your situation, but here are some things to consider if you already have an emergency fund:
- Saving for retirement
- Saving for business capital
- Real estate investment
- Stock investment
- Education funds for kids
- Vacation savings
2. Analyze Income and Expenses
Once you have a goal in mind, you can determine how much you can allocate each month by analyzing your income and expenses. First, calculate how much income flows to your account monthly by checking your recent paystubs and bank statements. Then, check how much you spend on essential bills. These cover all your necessities, such as rent, utility, groceries, and transportation.
Even if saving for your financial goal is the highlight of reverse budgeting, staying current on your essential bills is just as important.
3. Decide How Much to Set Aside
Now that you’ve learned how much you spend on the essentials, you can figure out how much of your income to allocate to your financial goal. You can use different methods to make this process simple. Experts recommend saving at least 20% of your income. For example, if you have a monthly income of $3000, you can allocate $600 for your savings using this rule. However, you can adjust this percentage depending on your income, expenses, and priorities.
4. Implement the Method
By this point, you clearly understand your expenses and the amount you can allocate for your savings. Having this knowledge on top of your mind will make implementing the reverse budgeting method easier. You can do this either via a manual or automatic approach.
If you use the manual method, you transfer money manually to your savings account the moment you receive your income. This approach best suits individuals who don’t get paid on a consistent schedule. For instance, if your income arrives in your bank account on the last weekday of each month, the date can vary from month to month.
You can opt for automatic transfers if you get paid on the same date every month. Most bank apps and websites allow you to make recurring transfers. After transferring your savings, you can pay your bills.
Next comes the fun part! You’ll rest easy knowing that you can spend the rest of your money without feeling guilty.
5. Evaluate and Adjust
In the ideal scenario, you’ll have enough money to cover your financial goals, needs, and wants. However, if you’re struggling to make ends meet each month, don’t hesitate to adjust your budget. You can also make lifestyle changes, such as eliminating unnecessary subscriptions or downsizing to a cheaper car. If you’re still struggling, you can find other ways to boost your income, such as looking for a part-time job.
While most experts recommend saving at least 20% of your income, it might not always be that simple in real life. Even if you can only afford to save 5%, this is still better than not saving at all. The key is to find what works best for your unique situation.
Pros and Cons of the Reverse Budgeting Method
Every budgeting method has its advantages and disadvantages. Let’s review the pros and cons to help you decide if the reverse budgeting method is right for you.
The pay-yourself-first approach is a relatively low-maintenance way to start budgeting. All you have to do is set aside your savings and spend what’s left. This method won’t require you to categorize and keep track of all your expenses, making it one of the best ways to simplify your finances.
Since this approach prioritizes your big-picture financial goals, it forces you to utilize your current income strategically. As a result, you avoid falling prey to unnecessary lifestyle indulgences while growing your savings.
The reverse budgeting method may not be suitable for every financial situation. For example, if you have high-interest debt, following this strategy can make it more challenging to pay your outstanding balance.
In addition, if you live paycheck to paycheck, transferring money from your account before settling your bills can put you at risk of an overdraft. Lastly, if your income constantly fluctuates, your cash flow may not provide the flexibility required to settle your financial obligations.
Other Budgeting Methods You Can Try
You can try other budgeting methods if you want a more detailed analysis of your spending habits. Here are some alternatives to consider.
- Zero-Based: This type of budgeting aims to make the most of every dollar by accounting for every single penny—whether paying your bills, buying groceries, ordering a pizza, or putting money into savings—until you end up with $0 left every pay period. You’ll have to log every expense—either manually, through a spreadsheet, or via budget apps.
- Envelope Method: This cash-based method entails setting a spending limit for every expense category, such as utilities or groceries, then filling an envelope with the allotted cash for that category. You can no longer spend money on a specific category if the allotted budget runs out, reducing the risk of overspending.
- 60/40: In this budgeting method, you allot 60% of your income to committed expenses and use the rest for retirement, savings, and wants.
- 50/30/20: This budgeting system allocates 50% of your income to necessities, 30% to wants, and 20% to savings and debt.
- 70/20/10: Similar to the 50/30/20 approach, this budgeting method allocates your income to different categories. In this case, 70% goes to monthly expenses, 20% to savings, and 10% to giving or debt repayment.
- 30/30/30/10: This budgeting method dedicates 30% of your income to housing, 30% to necessities, 30% to savings and other financial goals, and 10% to wants.
Start Taking Charge of Your Finances Today!
The reverse budgeting method is one powerful strategy you can try to start building your wealth. However, the most suitable strategy for you depends on your income, spending habits, and lifestyle. Don’t be afraid to experiment with different methods and adjust as you go along. As you learn and grow, you’ll find your financial stability improving.
At Power Finance Texas, we know how challenging it can be to manage your budget when financial emergencies arise. When you find yourself in a crunch, rely on us for quick and seamless same-day loans. Apply today!