With each new year comes New Year’s resolutions. It’s no surprise that along with getting in better shape, being better with your money consistently ranks amongst the top resolutions. Yet, more than 2/3 of Americans fail to keep a regular budget.[1] Why do so many attempt to keep budgets, yet so few succeed?
A better question is, are budgets really the only way to take control of your spending/saving habits? We know it can be difficult to maintain a budget, so we came up with a better approach. It requires no spreadsheets, no websites, no piles of receipts and won’t give you a headache. We call it “backward budgeting” and it has helped several people increase their savings and achieve their financial goals.
All It Takes to Start Backward Budgeting Is Understanding These Three Simple Concepts:
- Why traditional budgeting doesn’t work
- How to flip your mindset on spending/saving
- How to backward budget your way to financial success
Why Traditional Budgeting Doesn’t Work
Why is it that so many people have a hard time tracking and saving their money? The issue is bigger than you might think. The average savings rate in the US is just 5.5% of net income (income after taxes).[2] For most people, the lack of savings will cause a drastic reduction in their lifestyle once they retire. Here are three key reasons traditional budgeting doesn’t work:
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It’s Time-Consuming and Tedious
Most people would rather go to the dentist than sit down and record their spending. Reviewing your bank and credit card statements is nobody’s idea of a good time.
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Expenses Fluctuate Month-to-Month
In a perfect world, your expenses wouldn’t change from one month to the next. In reality, it’s new tires one month, vacation a couple months later, and a kitchen remodel after that. Keeping track of everything is like trying to hit a moving target. It’s nearly impossible, and it makes sticking to a budget very difficult.
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Even Websites Have Flaws
Some sites have nifty tools to track your spending. It’s better than nothing, but still not perfect. For example, websites can’t automatically track purchases you make in cash. They also won’t know if your friend paid you back for something you put on your credit card. Details like this can be frustrating and discourage you from sticking to your financial plan.
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How to Flip Your Mindset on Spending/Saving
Backward budgeting starts with changing the way budgets make you think about money. With traditional budgeting, you track all your expenditures into detailed categories, then focus on where you can make changes that will allow you to increase your savings. In other words, you think about spending first, then save what’s left over.
This is the exact opposite of what you should be doing.
Instead, you should focus on saving money first and spending what’s left over. This change in mindset seems small, but it will change your entire outlook on saving and rearrange your priorities when it comes to spending. It’s the spend first, save later mentality that explains why the average person in their 60’s has just $172,000 saved for retirement.[3] Using the 4% save withdrawal rule, that equates to only $7,000 annually to live off, which won’t get you very far. Flipping your attitude to save first, spend later is the first step towards achieving your financial goals, whatever those may be.
How to Backward Budget Your Way to Financial Success
Now it’s time to take a look at how backward budgeting actually works, as well as a few tips to help you implement this strategy in your life. The formula is deceptively simple, but that’s the point. Unlike budgeting, it takes almost zero effort to plan. A good starting point is finding out what your current living expenses are, something many people underestimate. Instead of tallying up each itemized expense, simply back into it:
Net Income – Savings = Living Expenses
Let’s say your net monthly income (income after taxes) is $5,000. If you’re saving $500 per month towards your goals, that means your living expenses are $4,500. If you want to increase your savings to $1,000 then your expenses must decrease to $4,000. As long as you know you’re saving enough, you are free to spend the rest on whatever else it is that you want–eating out, a nice home, vacationing, it’s up to you. No more tracking every expenditure, no more feeling bad about your guilty pleasures. Plus it gets even easier. Let’s look at two tips to help you keep your budget on track:
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Keep A Buffer
Everybody should have a buffer of a couple thousand dollars in their checking account. That way you can continue to save, even when unexpected expenses come up. Life happens, don’t let it throw your savings goals off track.
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Make it Automatic
Set up automatic transfers to your investment accounts and match them to the days of the week you get paid. Another option is to set up automatic deductions from your paycheck into your employer-sponsored retirement accounts. The money will be saved before you even have a chance to spend it. Save first, spend later.
Wrapping It All Up
The real purpose of budgeting isn’t just to track where your money is going. It’s to track where your money is going so you can make better decisions with it. If you regularly budgeted and discovered you were wasting money on eating out, but never did anything about it, that information does you no good. That’s why backward budgeting is so useful. It flips the script on traditional budgeting, from a task you dread to a tool that helps you understand the big picture:
If you are saving enough for your goals, then who cares what you spend the rest of your money on?
Just because backward budgeting is simple doesn’t mean it’s easy. It still takes discipline, and that’s why making your saving automatic and keeping a cash buffer are so useful. We hope backward budgeting will help you enjoy your life, have fun and spend your money on whatever makes you happy. Just make sure you are saving and planning for retirement.
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