Most budgets focus and are built around your expenses, but it doesn't have to be this way. With reverse budgeting, you save money first and spend the remainder later. After all, you can't spend money you don't have.
I am a big fan of reverse budgeting because I permanently save my money first when I receive my salary, no matter what budgeting method I have chosen for that period of my life. You should also do this if you are serious about saving money to achieve your financial goals.
Before you implement reverse budgeting, let's explore what it consists of, if you should try it, and see examples to understand it better. You can also check the 60/30/10 rule budget if saving is a big priority for you right now.
What Is The Reverse Budgeting?
Reverse budgeting is also known as the “pay yourself first” budget. After receiving your wages, you direct your money towards savings and investments first and then pay your bills and use whatever is left for basic needs and fun things.
As you can see above, the reverse budget method does not sacrifice your financial goals or basic needs. This budgeting method focuses on your financial goals and ensures that you pay your essential bills before you spend money on clothes or dine out a few times that month.
It's a minimalist budget, but you still have some work to do. You must check your bank account statements for the last months to see how you spend your money and make the required adjustments.
The idea of the reverse budget is to ensure you cut expenses and have enough money for the month after you have paid your financial goals. You don't sacrifice your financial goals, but you reduce costs elsewhere.
Who Is The Reverse Budgeting Ideal For?
The reserve budgeting method is ideal for anyone who wants to prioritize savings and usually has difficulty doing it, no matter what they try. If you like a minimalist approach, where you save money and then spend the rest you have, this budgeting type is a great option.
If you want to stay on top of your expenses, reverse budgeting will ensure you evaluate how you spend your money and why you weren't able to save some before.
Reverse budgeting is excellent if you:
- Want to prioritize your financial goals.
- Have difficulty saving money.
- Never achieve your financial goals.
- Prefer to adopt a minimalist budget style.
- Want to be on top of how you spend your money.
How To Budget Your Money With The Reverse Budgeting?
Now you get the gist of reverse budgeting, let's go deeper and break it down in more detail.
With reverse budgeting, you pay yourself first, which means you will put money aside to ensure you achieve your financial goals. You can have many different financial goals, and having more than one is essential, especially if you can afford to save money for them.
A few examples of financial goals:
- Buying a House
- Emergency Fund
- Debt Payments
- Real Estate Investments
- Starting a Business
- College Savings For Kids
- Retirement Contributions
- Stock Investments
- Sinking Funds
You need to define how much money you need to achieve each financial goal you propose to yourself. How long will it take to complete the value you want? How much do you need to cut from the rest of your expenses to do it? These are questions you need to answer.
The essential bills (needs category on most budgeting methods) encapsulate all the costs you can't avoid or would be difficult to live without. For example, you can survive without a gym membership or your Netflix account, but you can't live without settling your mortgage or the electricity bill.
A few examples of what is part of the essential bills:
- Utility Bills (Water, Gas, Electricity)
- Any Loans
Knowing how much you pay separately for each essential bill is crucial, and then adding all of them together even more. That's the difference between knowing if you can actually achieve your financial goals and where you need to cut some expenses.
The Rest Of The Money
The rest of the money will not be a lot since your financial goals and essential bills will take most of it. Whatever money you have left, you can spend as much as you want on things that bring you happiness (known as the wants category on most budgeting methods).
A few examples of what is usually part of the wants category:
- Entertainment Subscriptions
- Dining Out
- Memberships (gyms, professional organizations)
Remember that you can cut some expenses here, but you should never completely eliminate them. Life and budgeting without a bit of fun it's not worth it, and you will not enjoy a life where you don't go to eat out from time to time, watch a movie in the cinema, go on holiday, or buy a piece of clothing. Extreme budgeting is an excellent example of purchasing only what is strictly necessary, but it's worth it for a short time.
How Do You Set Up The Reverse Budgeting?
If you decide you want to move forward with the reverse budgeting method, here’s how you can set one up.
1 – Calculate Your After-tax Income
So, the first thing you want is to calculate your after-tax income and understand how much money you will receive every month. Some people receive the same amount every month, but for others, it can vary, which makes budgeting a lot more complicated (but not impossible). If you are a freelancer, estimate how much money you expect for the next month. Some people get paid weekly and some biweekly, so you must adjust your budget according to your situation.
You can use the free tool on the IRS website to help you determine how much income you can expect to receive and how much taxes you will pay. However, if you have any questions, it would be better to speak with a tax professional.
2 – Use The Reverse Budgeting Template/Spreadsheet
Ensure you use the reverse budgeting template to keep organized and have a more reasonable perspective of what you need to do. It can be a spreadsheet you print and use/fill online or an Excel sheet. Whatever makes your life easier, it's what you should use. Don't forget your partner's income and expenses, and check the best personal budget categories for you.
I like Excel sheets because they are easy to use and modify if you need them, and they automatically calculate everything for you (if you have the correct formulas). Learn how to make a budget in Excel. However, if you don't like Excel or find it confusing, you can always use a spreadsheet you can fill on your laptop or even print.
3 – Set Up Your Financial Goals & Pay Yourself
Any budgeting method needs to have financial goals. Otherwise, it's not worth it since you don't have the motivation to stick with what you have planned. With the reverse budget, having financial goals is the main point of the budget. So you need to set financial goals for each month or even a year or five.
You need to use the reverse budgeting spreadsheet before setting up your financial goals to ensure you can put the amount of money you want aside. Nothing is worse than having an unrealistic budget in place.
You also need to know why you want to invest your money.
From the moment you know how much you need to allocate to each financial goal, transfer that money from when you get paid to a different account or an envelope at home. That way, you will ensure you are saving that money.
4 – Pay All Your Essential Bills & Spend The Rest
Now that you have paid yourself and ensured that you have money aside to achieve your short and long-term financial goals, you need to settle all your essential bills. You need to have money to pay your mortgage/rent, all necessary bills, groceries, and anything you can't live without.
After you have put money aside for every essential bill, you will have a certain amount of money you can spend for the rest of the month on things you want. This will be anything fun, like buying clothes, going out with friends, traveling, etc.
To ensure you can hit your financial goals and save for them, you want to try to cut some of your expenses, both essential and non-essential. This could be something like renegotiating your mortgage with the bank, trying to reduce your bills, going out less with your friends, eating out fewer times, etc.
5 – Evaluate And Adjust Your Spending
Finally, you will need to evaluate and adjust your personal budget regularly. First, check your spreadsheet and see if you need to make any adjustments to ensure you are saving as much money as you want to achieve your financial goals. The second thing you need to do is evaluate it at the end of each month and see what went right and wrong and make more adjustments.
Every month you will need to evaluate and adjust your budget. Don't get discouraged if you fail or it doesn't go like you wanted because you will not get everything perfect on the first attempt. Even the more experienced budgeters like me still make mistakes after years of budgeting.
Reverse Budgeting Examples
The average American earns approximately $51,480 gross per year in the USA, equivalent to $4,290 gross per month. So that’s the value I will use in my example.
Note: For your information, I have researched a lot about how much the average American pays for rent, bills, groceries, etc. However, it would help if you kept in mind that it varies significantly in each state. These examples are only for you to understand better how reverse budgeting works.
The first example is for a single person who splits a house with someone that is not their partner and has no kids.
What I love about reverse budgeting is that after you have set money aside for your financial goals and paid your essential bills, you can spend the rest of your money on fun things without feeling guilty since you know you have done everything correctly.
As you can see, the first thing you do with your salary is to transfer money to your financial goals account. After that, ensure you have enough money to cover all essential bills, and then decide what you want to do with the rest. But, of course, this is just an example for you to see how the reverse budget works, and sometimes it's not that easy.
I exaggerated the values in this second example for you to know what you need to do if you only have $70 for the entire month spent on the fun stuff. You may not even have enough to pay your financial goals and essential bills. If you don't, the first thing you need to do is to try to reduce your necessary bills.
Try to reduce the electricity bill by changing the house's lights and using the washing machine less. Cancel some memberships you think are really needed when they aren't. Don't use the car to go everywhere; walk and save fuel.
You may have to reduce the money you put into your financial goals, but with reverse budgeting, that is always the last alternative since the focus is on them.
Is The Reverse Budgeting Good For You?
If you want a budget that focuses heavily on ensuring you hit your financial goals no matter what, reverse budgeting is the one for you. This is because this budget method puts your savings, investing, and other financial goals ahead of everything else.
Just remember that sometimes just because a budgeting method didn't work for you doesn't mean you can't try another, like the 50/40/10 rule budget or the zero-based budget. After all, you must try different budgeting techniques to ensure you pick the best one according to your needs.