Pay yourself first: how to reverse budget

From children's storybooks to financial planning workshops, the lessons surrounding money typically involve living frugally enough to save, and there's wisdom in that message. However, putting money away for a rainy day is sometimes easier said than done. Here, we look at reverse budgeting and highlight how it can help you accomplish your savings goals. 

Pay yourself first

The three simple words "pay yourself first" are at the heart of reverse budgeting. Here’s how a typical household budget works:

1. Earn money.

2. Pay bills.

3. Buy necessities.

4. Pay for non-necessities, like dining out and travel.

5. If there's any money left over, save part of it.

Reverse budgeting turns a traditional budget on its head. Here's how it works:

1. Earn money.

2. Set aside funds to save and invest.

3. Use money that's left to pay bills and buy necessities.

4. If there's money left after paying bills and buying necessities, cover the cost of non-necessities.

Create a reverse budget

Step 1: Audit

Like any good budget, a reverse budget begins with a spending audit. Conducting an audit is as simple as going back through your bank and credit card statements for the past few months to remind yourself of your expenses. Make a separate list for each month. Here's what you'll look for and make a note of:

1. Bills that must be paid each month, like housing, transportation, utilities, groceries, and paying off debt. Add any other bills that are due each month.

2. Necessities, including medication, clothing, and pet care. Although these may not be actual bills, you spend money on them each month.

3. Miscellaneous for things like going out with friends, children's sports leagues, or hobby supplies.

Step 2: Find an average

Once you're done with the list, go through and add up how much you've spent each month. To get an idea of your average spending, add the three totals together like this:

Next, divide the total by 3 to find your average monthly spending. In this scenario, average monthly spending would be $4,333. (That’s $13,000 divided by 3.) 

Set this list aside until you've completed the next step.

Step 3: Determine how much you want to save 

Imagine your monthly take-home pay is $6,000, and you want to save $2,000 a month. That means you create a budget in which $2,000 immediately comes off the top of that $6,000 and goes directly into savings or an investment account. However, that leaves you with $4,000, $433 less than you need to cover your average monthly spending. 

Instead of trimming how much you're going to save, make cuts from the other end of the budget.  It's time to go back to the list you created in step two and see where you can make cuts to your current spending. The first place to look is in the miscellaneous category. Could you ditch any of your subscription services without feeling the pinch? Could you borrow books from the library rather than buying them online? Could you have fun eating out twice a week rather than four times? Miscellaneous expenses tend to add up fast, so when it comes to cutting back, that's where you'll find the lowest-hanging fruit. 

If you still have to make cuts once you've gone through miscellaneous spending, move on to necessities. For example, if you spend several hundred dollars on clothing and grooming supplies each month, could you trim the budget by $100? In other words, you don't have to slash the budget to the bone, just enough to allow you to prioritize saving.

Step 4: Leave yourself some wiggle room

For the sake of this illustration, let's assume you've managed to trim the budget and bring average spending down to $4,000. That means you'll get by just fine, even without the $2,000 going into savings. That's great work! 

However, life (and unexpected expenses) happen, and you don't want to cut yourself so short that you risk a bounced check or other banking error. Make sure you always keep enough in your checking account to absorb a few surprises. How much you keep is up to you. It can be as little as a few hundred dollars or enough to cover a month's worth of bills. 

If you already have some extra in there, leave it. If not, save enough to pad your checking account before you automate savings.

Step 5: Automate

The best way to stick with a reverse budget is to set up automatic transfers from each paycheck into savings. If you're putting part of the money into savings and the rest into investments, set up both as auto-transfers. 

When you automate, you remove the temptation to spend the funds because they never hit your checking account. 

While we're on the subject of reverse budgeting, don't forget that employee-sponsored retirement plans like 401(k)s are one way to make professionally managed investments—and it’s already automated. As a bonus, a 401(k) is funded with pre-tax dollars. Say you put $1,000 a month into your 401(k). That's $1,000 that you don't have to pay taxes on until you're retired and begin making withdrawals. Money management is all about weighing the benefits of all your options. 

If your income barely covers your current bills or is variable, how about starting out small? Set up a reverse budget that earmarks $100 monthly for savings. Once you've become accustomed to that, you may find you can increase your contribution. 

The point is this: Paying bills in full and on time is important, but you and your future remain the priority. Pay yourself first, and watch your savings grow.