In this article:
- How Does a Reverse Budget Work?
- How to Create a Reverse Budget
- Pros and Cons of a Reverse Budget
- Should You Use Reverse Budgeting?
When it comes to building the financial life you want, setting goals will only get you so far. Following through with your daily choices is just as important, and it can be an uphill battle. But creating a budget that tailors your spending toward your savings goals can bring those goals within reach.
A reverse budget is when you pay yourself first and then base your spending around what's left. It's a framework for improving your financial health by thinking first about the long term, then taking care of the short term. Here's how it works, the pros and cons of reverse budgeting and how to create your own reverse budget.
How Does a Reverse Budget Work?
Reverse budgeting is another name for paying yourself first. When you create a reverse budget, you first set aside money toward your saving and investing goals. Then, you allocate what's left toward your expenses and discretionary spending.
Unlike other types of budgets that categorize all of your spending and set guidelines for how much you'll spend in each category, a reverse budget looks at the bigger picture. Your savings contributions are automatically taken care of each payday. After that, you pay for your expenses and spend whatever is leftover—without the need to meticulously track anything.
How to Create a Reverse Budget
A reverse budget works similarly to other types of budgets: You'll need to start by figuring out how much you can afford to save, automate what you can and then readjust as needed. Here's how to do it.
1. Do a Spending Audit
To know how large to make your savings goals, you'll need to take a pulse on your current cash flow. Go through your bank and credit card statements and tally up your spending on basic essentials like housing, bills, food and the like. Also note how much you typically spend on fun stuff like eating out and shopping.
While you may decide to cut back in these areas to prioritize your goals, trying to drastically cut back overnight can be a recipe for burnout. That said, you might find shaving off a few monthly subscriptions or opting to cook more at home can help you lower your baseline spending.
2. Brainstorm Savings Goals
Brainstorm savings goals that you want to work toward. Here are some ideas for what to save for:
- An emergency fund
- Home down payment fund
- Vacation fund
- Back-to-school fund
- Home or auto repair fund
- Vet bill fund
- Holiday shopping fund
3. Create Specific Milestones
Once you have a list of things you want to save toward, pick a couple to start with. Then, turn them into specific, attainable financial goals.
For example, you could aim to save $5,000 toward a down payment in the next year. To get there, break that goal down into smaller goals. In this example, you could aim to save $400 in your down payment fund each month.
Make sure to be realistic in your savings goals to avoid leaving yourself short when it's time to pay bills, and ensuring you still have some cash leftover to treat yourself.
4. Automate Your Saving
To make your reverse budget easy to stick with, automate it. Set up automatic transfers into savings each payday to fund your goals. You may even be able to split up your direct deposit to land in two different bank accounts.
It's a great idea to keep your savings separate from your spending money to avoid dipping into savings when you don't have to. A high-yield savings account is a great place to store your short-term savings because you'll earn more interest on your money without having to sacrifice liquidity.
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5. Monitor for Overspending
The idea behind a reverse budget is that once you meet your saving goals, you can use the remainder of the funds in your bank account for whatever you want. But that said, you'll need to ensure you can meet your basic, committed expenses before you spend freely elsewhere.
You may find it helpful to set up spending alerts through your banking or credit card app to avoid unknowingly depleting the funds in your bank account or running up a large credit card bill.
6. Make Adjustments as Needed
As you try out your new reverse budget, you may find that you're not leaving yourself enough flexibility for bills and spending. You can always lower your savings transfers a bit to make your spending plan easier to stick with.
On the other hand, if you find that sticking with your new reverse budgeting is a breeze, try upping your savings ratio a bit. Even saving an extra $20 a week will leave you with $1,000 more by the end of the year. That could be a pretty good padding for your emergency fund, or a sizable holiday gift-giving fund.
Pros and Cons of a Reverse Budget
Paying yourself first has clear benefits, but reverse budgeting is just one approach to creating a spending plan. Before you commit to a reverse budget, consider the benefits and drawbacks.
Pros of Reverse Budgeting
- It can help you reach your goals faster. One of the biggest benefits of reverse budgeting is that "paying yourself first" works. By focusing on your savings goals before your expenses and spending, you'll be more likely to save consistently.
- It's flexible. In comparison to more rigid budget plans that require you to categorize all your spending into specific categories, reverse budgeting is uncomplicated and requires very little upkeep.
- Your risk of budget burnout is lower. If you've found that the upkeep of highly involved budget planning leads you to get fatigued and quit budgeting, a reverse budget may be much easier to stick with.
Cons of Reverse Budgeting
- It could lead to overspending. If you declare open season on spending as soon as your savings goals are funded, you could end up spending more than you can afford to.
- Focusing on debt may yield better results. If you're carrying a lot of high-interest debt, you may find it more motivating to start with a debt payoff plan such as the snowball or avalanche method, and then create a debt repayment budget.
- Paying yourself first can be difficult when money is tight. If you're working with an especially tight budget, you may find that putting your budget into survival mode until you're able to boost your income or reduce your expenses is a more attainable move.
Should You Use Reverse Budgeting?
Whether or not you should use reverse budgeting comes down to your personal financial situation and needs.
Overall, reverse budgeting can be a great way to improve your financial health and align your spending with your goals. It's an unfussy approach to budgeting, because you don't have to track every dollar.
That said, if you struggle with overspending or just prefer more structure, consider other types of budget plans. Envelope budgeting or zero-based budgeting take a more detailed approach.
Build a Saving Habit
Reverse budgeting can help you prioritize your savings goals to build the financial future you want. By transferring money directly into savings each payday, you can help curb the temptation to spend the money you want to set aside for the future. That can make a huge difference for building wealth over time, especially if you balance short-term savings with investing toward long-term goals for retirement.
Beyond building a budget that puts saving first, be sure you're prioritizing building credit too. Improving your credit score can help you qualify for advantageous rates should you need to borrow down the line. Start monitoring your credit for free through Experian for alerts to changes in your score and personalized advice on how you can grow your credit over time.
