This post was brought to you by my hubby. I spent the entire afternoon cooking Ethiopian food so he kindly offered to write-up his thoughts about reverse budgeting.
Is reverse budgeting the quick, low stress way to save money?
Our family uses the traditional budgeting method out of practice. We are big fans of the tried-and-true traditional budgeting, but understandably not everyone finds it appealing or fun to do. It takes diligent time and effort to track spending, which not everyone can or wants to do. It can be emotionally drained to keep setting and falling short of your goals.
Related: Is budgeting depressing? Then you should read this…
How to Reverse Budget
The reverse budgeting method operates on the principle of “out of sight, out off mind.” The idea is to save money before you’ve had a chance to spend it. This is why many people refer to it as “paying yourself first.” Essential, you’re pretending your paycheck is smaller than it actually is in order to force yourself to live on less and save the rest. The way to accomplish this is to use one or more separate accounts for your savings. You keep a primary account that you use for your day-to-day expenses, and you transfer your money into separate accounts based on your savings goals.
Many people are already reverse budgeting without realizing it.
If you contribute to a retirement account, such as a 401k, though paycheck deductions then you’re one of them! By contributing to a 401k, you’re putting money aside for retirement without ever seeing that money in your own savings account, where you’d be tempted to spend it on immediate wants and concerns instead of saving it for retirement
Related: Is your 401k plan & match good enough?
While paycheck deductions to a retirement account is the most common application of the principles of reverse budgeting, it’s easy to apply the same thing on your own in savings accounts. If your employer supports direct deposit, they may support splitting the deposit between multiple accounts, is as easy as having the money you want to save deposited into a separate account. If not, schedule a recurring, automatic transfer to run after you get paid to move money to your second account. This way you never forget to save!
If you aren’t big on banks and savings accounts, you could take a cash oriented approach by putting can into separate envelopes for your savings goals. The same principle applies no matter where you save! For example, if you’re trying to build an emergency fund, you could transfer $100 to a separate account every time you receive a paycheck. You then leave that account untouched and live off the rest of the your paycheck. When an actual emergency comes up, like a medical issue or your car breaking down, you’ll be much happier to have money to spend on it.
Reverse Budgeting vs Traditional Budgeting
With traditional budgeting, I sit down every week or two and go through about twelve accounts, adding any transactions to a spreadsheet for tracking all our expenses and income. Reverse budgeting doesn’t have any of that. There’s no tracking expenses, categories, etc. If you’re doing it right, it shouldn’t take any action from you after you’ve set it up. And you always meet your savings goals as long as you don’t have to withdraw from any of your separate savings accounts.
Winner: Reverse budgeting method
Budgeting aims to prevent overspending by setting categorizing spending goals for the categories. It then provides you feedback about how you’re doing against your goals so you can adjust as necessary. This requires some amount of internal motivation to hold yourself to your own standards.
Reverse budgeting removes the money you want to save from your primary account. This can help you feel like you have less money available to spend, so discourages spending all your savings on unplanned purchases. It is, of course, still possible to spend more and pay it off with the money you saved, but it at least introduced another barrier towards doing so.
Winner: Reverse budgeting method
Traditional budgeting forces you to review your spending, which comes with several benefits. It helps you identify unauthorized out fraudulent activity, which let’s you dispute it before too much time passes. Traditional budgeting helps you identify if you’re receiving about service fees in your accounts. It also helps you identify areas in which small purchases are adding up more than you thought, and it reminds you about any subscriptions you may be able to request better deals (e.g. calling Comcast to ask for a contract at reduced price) or cancel all together and not miss.
Reverse budget doesn’t care where you spend your money, so it doesn’t come with those benefits. It won’t let you know if you’re still being charged for AOL dial-up even though you switched to high speed internet years ago.
Winner: Traditional budgeting
Extra or Increased Income
Sometimes people find themselves in the unusual situation of making more money. You may be in a situation like mine where you get paid bi-weekly, so you have some months with an extra shifts or extra paychecks. When I get placed onto the weekly on-call rotation I am compensated an extra paycheck for the overtime I put in. On our journey to total financial independence, I’ve been happily picking up extra shifts from fellow coworkers who have life obligations. With any luck, I’ll be on-call on Thanksgiving. Seasonally, my wife has Airbnb which is very seasonal dependent work. Our household income varies wildly depending on our withholding and our Airbnb.
With traditional budgeting, an increase in income does not automatically become available for spending. You must make a conscious decision about how to allocate your increased income, which can help limit lifestyle creep.
With reverse budgeting, the default behavior is to continue saving exactly how much you were previously (except in the case of percentage of paycheck contributions to retirement), making the rest available for discretionary spending. In this case you need to make a conscious decision to save more to match your new savings potential.
Winner: Traditional budgeting’s default of saving extra income gives it the win for preventing lifestyle creep.
Some months, you have unexpected expenses that can’t be paid with your usual income. No matter whether you budget or reverse budget, an emergency fund is what’s going to help you most when the inevitable happens.
Related: Download our FREE Google Docs budget template with just an e-mail.
A budget will only helps you with unexpected expenses if you budget in savings for an emergency fund. People can use budgets to allocate all their spending without saving any of it so the risk is up to the individual.
Similarly, a reverse budget only helps with unexpected expenses if you’re transferring money to an accessible savings account. However, by splitting up money into different accounts, you have a higher risk of over-drafting with normal expenses if you aren’t careful.
If you have an automatic transfer setup and you’re late depositing a paycheck, you could overdraft. If you spend more than you realize and you have automatic payments enabled for bills/rent/mortgage, you could overdraft.
Winner: Traditional budgeting
Both traditional budgeting and reverse budgeting is better than not budgeting at all. Both methods has its advantages and disadvantages. For the hands off approach, a reverse budget is more advantageous because it won’t have the feeling of constraint by the traditional budget. In reverse-budgeting, billings and automation is your friend. If you’ve had trouble saving in the past, start small. Start saving $10 a paycheck into another account. If you do find for a month, increase the savings to $20. Keep increasing the savings account over time to find what you’re comfortable with. If you feel too constrained then go back to the last savings rate and stick with it. The reverse budgeting method can allow you live within means and does not require detailed bookkeeping on your accounts compare to traditional budgeting methods.
Is anyone using reverse budgeting? How do you feel about the reverse budgeting method? Fad or fabulous?
Yet Another PF Blog says
I’m a do-a-little-of-both budgeter. I do 401k and ESPP contributions first, spend as I need to (with conscious tracking), and dump the remainder into taxable brokerage accounts. No budget caps but some general guidelines and understanding where my money is going. Whatever works.
Also that Ethiopian food looks delicious. Jared is a lucky (and well-fed) guy.
Our budget caps are never reached anymore, and instead of adjusting we’ve just been interested them and using our budget more for expense tracking. After a certain point, it didn’t make sense to keep trying to tighten spending, but tracking is still very important to us.
I’ve moved to a combo style budget where I will automate a relatively safe percentage to savings automatically, and then my budget will build in a higher constraint so I theoretically should be moving additional money into savings at the end of the month. I mostly find this easier because every time I was transferring money into my savings account at month end, it would take a week to process. Then I wanted to transfer some money out of that for investments which would take another few days. It was just too much waiting!
I always just wonder how people who reverse budget keep track of their money. I guess both methods require you to actually know how much money is in your checking account. It was always in my head like…if you reverse budget but you never know how much is in your checking account anyway…won’t you just go over budget? It’s surprising how much fake partitioning of our money helps bucket our spending!
We do something similar! We have regular, automatic contributions to a brokerage account during the month based based on what we should be saving every month, then manually transfer any extra at the end if the month. It helps us deal with our partly seasonal and irregular income.
I think people who reverse budget primarily keep track of their checking account balance. It’s essentially budget with a single category and a spending limit of the account balance.
Revanche @ A Gai Shan Life says
I do a combination but mostly am rooted in the reverse method. I allocate investing and savings first, calculate what we really need to pay the bills and a little extra, and then shift the extra (if any) into savings.
Sounds like a good approach to me. I think a lot of PF bloggers in particular get diminishing returns from budgeting as they get their expenses down to something minimal (for their chosen lifestyle) and regular. At that point, it probably make more sense to save the overhead of budgeting. I’d still recommend newcomers to at least try budgeting first.
Sarah | Smile & Conquer says
Now you’ve got me craving Ethiopian food!
I’m definitely in the reverse budgeting category. Every payday I go in and split up the new money between my various accounts/investments and leave hardly anything behind (usually a buffer of about $100). A lot of my savings/bills happen automatically which makes everything simple and means I don’t have to spend a lot of time on my budget every month.
Not going to lie, Ethiopian food is pretty great.
Automation is really the way to go when your income and expenses are predictable enough. We have frequent deposits from Airbnb, so our buffer is constantly replenished. That prompted weekly transfers into a brokerage to keep the money working.
Ms. Frugal Asian Finance says
The Ethiopian dish looks DELICIOSO! I LOVE Ethiopian bread. I think it’s one of the best parts of Ethiopian food. Yum yum!
I think Mr. FAF and I do the reserve budgeting too. We don’t have an itemized budget. We just try to spend money on what we need and keep our overall spending to a minimum. After Mr. FAF started his new job, we have also been maxing out his 401(k) contribution. Out of sight, out of mind! It’s especially good for saving money hehe.
I wish I maxed out my 401k contributions when I started working, but alas I didn’t know much about personal finance until I met Lily.
We did the just trying not to spend much money thing too for a while before we started budgeting. Now we’re moving more towards automated savings and paying less attention to budget caps, since our spending had gotten pretty minimal and consistent.
Grant @ Life Prep Couple says
Nice write up Jared. I agree with your breakdown of pros and cons.
We use what you would call a reverse budget but we still track spending once per month. We like the flexibility of being able to kind of have money shift around. One month might be $400 for groceries and $200 eating out and the next might be $500 and $100. I think tracking is still important though to see where the money is going though.
Oh neat, you guys separate eating out and groceries instead of mixing the two! We were thinking of doing that.
I has never really thought about calling it Reverse Budgeting Method, but I have always tried to pay myself first. I guess I use both methods, but like you said if a person is budgeting in general that is a good thing. I think I will continue to use both methods. I still need my spreadsheet. It is my addiction. I guess the first step is knowing you have a problem:) Great post!
That’s a GOOD problem to have!!