Traditional budgeting requires you to itemize all your expenses and then see if your income covers them. With traditional budgeting, the process typically leads to paring back on some expenses to make room for others.
While this method is very practical and works for many people, there’s another way to budget that might work better for some people known as “backward budgeting.” Let’s take a look at what it is and how it can help your finances.
What Is Backward Budgeting?
Backward budgeting is a fancy way of saying “pay yourself first,” according to Tom Thunstrom, a small business finance writer at FitSmallBusiness.
“Paying yourself first is putting money away in savings before figuring out the rest of your budget,” he said. “You would establish a benchmark goal of how much you save, deduct that from your net income, and then establish the rest of your budget thereafter, including housing, utilities, food, and so on.”
Or, in an equation: NET INCOME – SAVINGS = REST OF MONEY TO BUDGET
According to Thunstrom, if you find with this method that the rest of your expenses are exceeding the rest of your allotted money, you adjust your savings as needed. Or, you can pursue picking up an effective side hustle to help you get some extra income.
Why It’s Effective
Backward budgeting can help prevent incidental expenses, such as your daily coffee, from adding up, Thunstrom explained. “If you stick to a goal of saving $500 a month and you’re spending $120 a month on your daily double latte extra soy whip and then are unable to meet your savings target, you can adjust your daily latte habit to maybe once or twice a week to help you attain your target.”
Some experts also advocate that backwards budgeting is less stressful and puts an emphasis on saving over spending. “However, like with any budget plan, discipline and consistency is needed to make it work.”
It Helps You Save Toward Specific Goals
“Using a backward budget is an excellent strategy for making sure you put money toward your most critical financial dreams,” said Laura Adams, MBA, a personal finance expert with the investing app, Finder. “Then you have to live off your remaining income for fixed and variable expenses, such as housing, groceries, transportation and insurance.”
There’s Less To Track
Another benefit of using a backward budget, according to Adams, is that you don’t have to keep detailed records of your spending. “You attack your most significant financial priorities first and then make sure you manage the remainder of your income wisely. I’ve always used a backward budget and find it the easiest way to manage my money successfully,” she said.
You Can Use the 50/30/20 Rule
Adams recommends that if you do backward budgeting, you allocate approximately 50% of your take-home income on necessities, such as food, housing and medical needs. Then you put about 30% toward optional expenses, such as dining out, clothes, vacations, gifts and other “wants.” Finally, at least 20% of your income goes toward retirement savings and getting out of debt.
It Helps Curb Spending
Backwards budgeting may also help “restrict impulses of human behavior as outlined in behavioral economics — i.e, that people are short-term biased and irrational with their spending,” said Scott Nelson, CEO of MoneyNerd Ltd, which offers financial advice and education.
“Instead of having some leftover budget and rewarding themselves in the present by buying something, stating ‘I’ll save next month’, after contributing to savings first people have no choice but to be really strict with their budget and completely restrict their lifestyle spending.”
It Helps You Focus on Long-Term Goals
Yet another benefit of this way of budgeting is that “it allows [people] to see the bigger picture and work towards their long-term goals,” said Ari Shpanya, CEO and co-founder of LoanBase, a site that demystifies investing and budgeting.
“Someone who is backward budgeting will have a clear idea of what they want to accomplish in the long run. Whether it is a retirement plan, paying for college for their kids, or paying off debt by a certain date, backward budgeting is the best way to set and accomplish monthly goals that will help you achieve those desired long-term goals. And the best part is, it’s even easier than regular budgeting.”
You Have a Clearer View of Your Needs
Looking at your past expenses also gives you a clearer view of your recurring needs, so you can plan for them better moving ahead, said Jeff Zhou, a personal finance expert and CEO of Fig Loans. “You can evaluate expenses that you could have avoided and find ways where you can cut your spending and save money.”
You Can Stick To Your Budget
Perhaps most importantly, Zhou said, “It helps you stick with your budget because you know your actual rhythm and you can create a game plan for some expenses that aren’t regular.”
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