What Is Reverse Budgeting And How It Can Help You Save
If you had an unexpected breakdown in your car and the repair cost 3,000 dollars, could you pay it in cash? Or even worse, if out of obligation you had to buy a new car because the current one does not give more of itself, would you have to ask for a loan to pay it? Let’s talk about the type of budget, the reverse budget and how they can help you with this type of unforeseen event.
Spending is too easy and saving is no fun. In addition, we live surrounded by stimuli that tell us “change your car”, “buy the new iPhone 11”, “flights to London at 50%”, “finance the house of your dreams” … But how many stimuli try to convince us that should we save? Very few.
The problem is that maintaining habits of life based on consumption day after day and month after month will end up turning your personal finances upside down and, as a consequence, you will end up having serious financial problems in the future.
The solution passes through savings but you know what is one of the best ways to save each month? Using a budget. We explain it to you.
How to save with a conventional budget
If you do not keep track of your income and expenses, it will be very difficult for you to save. For this reason, one of the first steps to start saving is to prepare a monthly budget, planning both your expenses and your monthly income.
There are many ways to save on a budget, such as reverse budgeting, but the conventional way is as follows:
• I make a list of my income: payroll, recurring income, profitability of my investments, etc.
Difficulty level: low.
• I make a list of my expenses: mortgage, rent, loans, supermarket, car, leisure, insurance, ant expenses, etc.
Difficulty level: medium.
• I put myself into saver mode and spend less than I earn: you only buy the clothes you need; you reduce your spending on leisure, I don’t change my phone every few years, you unsubscribe from HBO, etc.
Difficulty level: high.
• What I have left over at the end of the month (if I can get it over), I save.
Is this an effective method? Yeah right if. But it has its drawbacks. The main one is that the budget is like New Year’s promises: we all know we need to make changes in our lives and put a plan in place to achieve it, but most of us end up abandoning the plan within a few weeks.
If we save until the end of the month, we will have to face the problem that spending money is too much fun. Almost everything that is cool, we like or feel like it involves spending money. Therefore, if you have money available to spend it, you will most likely spend it, even if you know that this expense is not reflected in your budget.
To solve this problem, you could put your budget backwards and do what is known as reverse budgeting or reverse budgeting.
The reverse budgeting method
As you just saw, most people start a budget by spending first and saving later. The problem is that by the time the last days of the month arrive, there is hardly any money left for savings.
These people are not particularly motivated to reduce their level of spending because they can cover all their needs, both real and invented, with their current income. Their quality of life is good, or at least they think so, because they do not deprive themselves of almost anything, but the consequence is no financial discipline and a savings account that never grows.
These people are not particularly motivated to reduce their level of spending because they can cover all their needs, both real and invented, with their current income. Their quality of life is good, or at least they think so, because they do not deprive themselves of almost anything, but the consequence is no financial discipline and a savings account that never grows.
To put it into practice, you only have to withdraw the money you want to save from your checking account the same day that your payroll is entered and force yourself to live with what is left in the account.
For example, if you earn 1,500 dollars per month and want to save 20% of your income, withdraw the 300 dollars from your checking account at the beginning of the month and put it in a savings or investment account. In this way, for the rest of the month you will only have 1,200 dollars to spend.
Advantages of the reverse budget
The main advantages of reverse budgeting are the following:
• You prevent your mind from playing tricks on you: if there is no money, there is no temptation to spend it.
• Schedule your expenses based on your savings and not the other way around.
• You create a habit of saving, so necessary these days.
• You save automatically (for that you have to program a monthly bank transfer from your checking account to your savings account).
A very important aspect of the reverse budget method is that you can correctly establish the amount of money you want to save each month. If you’ve never saved anything, don’t expect to save half your salary the first month. It would be a better idea to do it in a staggered way.
We propose two alternatives:
• Save a fixed amount of money. For example, 50 dollars for month 1, 75 dollars for month 2, 100 dollars for month 3 … Or if your income is higher, 150 dollars the first month, 300 dollars the second, 400 the third …
• Save a percentage of your salary. For example, 5% for month 1, 10% for month 2, 20% from month 6 …
Scaling your savings is the best way to slowly move towards your ideal monthly savings with this reverse budgeting method. As you meet your small short-term goals, increase the goal over time to reach other medium and long-term goals.
