What is Reverse Budgeting?

What is a Reverse Budget?

Reverse budgeting, also known as the “pay yourself first” method, emphasizes meeting your savings goals like putting money into your retirement fund before other expenses, even including your living expenses.

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How to Create a Reverse Budget

Follow these steps to create a reverse budget:

Determine Your Financial Goals

Figure out your long-term and short-term savings goals, and your priorities for either. For example, your retirement fund is a long-term savings goal, while saving up for a new household appliance is a short-term savings goal. But you might also need to replace your current car. Determine how much you can put towards retirement or investments, an emergency savings fund, and a lesser amount towards major purchases. The rest of your paycheck can go toward necessities, like rent, utilities, or student loan payments.

Start With the 50/15/5 Rule

Use the 50/15/5 budgeting rule as a starting point for your reverse budget. This rule states that you should put 50% of your monthly income towards necessities such as rent, mortgages, and utilities, 15% towards your retirement savings, and 5% of your income toward short-term savings and debt repayment. For example, if you make$4,000 per month, you’d put $2,000 for necessities, $600 for things you want, and $200 for your savings. The remaining 30% that you bring home can be used to pad your accounts with additional money, save for various goals, or used for gifts or a night out.

Modify Your Reverse Budget as Needed

If you feel like your savings aren’t growing, look at your “wants” and “needs” spending. Is there anywhere you can cut back on those categories? On the other hand, there may be some months when you need to put less money toward your savings. For example, an emergency vet bill may require you to put less money toward your savings and more money toward your “needs” spending.

The Pros of Using the Reverse Budgeting Method

Since this budgeting method prioritizes your savings, it’s great for those who want to focus on expanding their savings and reach their savings goals even faster. Many people find that the reverse budgeting method is easier to keep up with than other budgeting methods. Since the primary focus of this budgeting method is expanding your savings, you don’t have to create an itemized list of everything you spend money on.

Another reason why the reverse budgeting method is so easy is because you can automate it. You can set up your bank account to automatically move money into your savings account or retirement funds each month which can help you save time and stay on track toward your goals.

The Cons of Using the Reverse Budgeting Method

If you’re someone who has a lot of debt, the reverse budgeting method may not be right for you. If you’re in a lot of debt, prioritizing paying off those debts first is more beneficial so that you’ll be closer to financial freedom.

Another disadvantage of the reverse budgeting method is that it might not be the best for those with a variable income. For example, if you’re a contractor with a varying paycheck, it may be difficult to determine how much you can put toward your monthly savings.

If you choose a reverse budget to guide your finances, be aware that it can lead to accidental overspending. For example, those who focus on their savings goals may forget to also focus on their “wants” and “needs” spending categories.

Reverse budgeting can help put you on track toward meeting your savings goals. If you’re interested in enhancing your financial knowledge, learn about the zero-based budget or how to make a monthly budget.