- Why traditional budgets don't work
- What is a backwards budget?
- How to do one
- Who it's for
- Who it's not for
- How this might be the quickest way to get ahead financially
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I don’t know about you, but one of the reasons I avoid budgeting is because I can never, ever see how we’re going to live and save and pay off our debts.
When I look at our previous years’ expenditures and try to forecast and budget for the following year, I tend to just give up.
I can never see how it’s ever going to work: I lose hope, I give up, I close the spreadsheet and I walk away.
That’s how it’s always gone for me. Budgeting is a great way to analyse spending for me, but not a good tool to utilise for planning.
One thing that changed all that is the Backwards Budget.
I’d heard about Backwards Budgeting years ago, but how it landed for me was “pay yourself first”. In other words, go out, spend as much as you want and then, if there’s anything left over, put it away in savings.
Needless to say, there was never anything left over. I’d totally misunderstood the concept.
The “pay yourself first” bit is about paying off your debt, then paying into your savings before you pay for anything else. It’s not about spending what you want and paying bills with what’s left.
Sad but true.
I wish someone had explained this to me years ago. Like most people, we currently have very little in our savings accounts and we have a life filled with debt. Living that way is stressful and unpleasant and stifling.
We dug our heads in the sand about this for years and pretended this wasn’t happening, telling ourselves we’d rather “expand” than limit ourselves by budgeting.
But the unfortunate thing is, our very actions – not budgeting – made us feel more and more stressed, more and more limited, more and more stifled. The exact opposite of what we wanted to avoid by not budgeting.
Something had to change, and this is one of the things that did: creating a Backwards Budget.
What is a backwards budget?
Basically, a Backwards Budget is where you decide how much money you want to pay towards debt or into savings each month and then you live off what’s left over.
That’s it: you have only the remainder of the money to live off AFTER you’ve paid yourself first.
Traditional budgeting gets you to work out what you expect to spend on each category and what’s left over is the amount of money you can put towards debt repayment or savings.
Like I said before, budgeting in the traditional way can lead to a feeling of hopelessness and make us stick our heads firmly back in the sand.
This way – budgeting backwards – puts the control firmly back into our hands.
We decide how much we want to save.
We decide how much money we want to pay off our debt.
It takes the focus away from the bills and helps remove those hopeless and helpless feelings.
Why use a backwards budget?
When you decide to use a backwards budget, your focus is on how much you want to pay off your debts and how much you want to save or put into Super/pensions.
In other words, the focus is on you and your goals, the power over what happens lies with you.
With traditional budgeting, the focus is entirely on your expenses. The power in this situation is out of your control: it depends on what bills come in.
Steps to create a backwards budget
1. Take a long, honest look at where you’re at financially right now:
- What debts do you have?
- What savings do you have?
- How much is in your super/pension/401k?
2. Decide what your financial goals are. Do you want to:
- Build an emergency fund (3-6 months of expenses)
- Pay off:
- your mortgage
- any car loans (or sell your cars and buy new ones cash)
- credit cards
- Save at least 10% of your income for retirement
- Save a deposit for a house
- Put aside money for your child’s school or Uni
There are plenty of other things you could write down, just list them all out.
3. Decide which of your financial goals are to be given priority,
i.e., pay off the highest interest loans/credit cards first before you pay off the mortgage.
List them out in priority order, put work on only the first 2 or 3 for now. As you pay them off, things further down the list can be added.
4. Work out:
- How much money you want to pay to yourself in total each month (this can be a fixed amount or a percentage of your income), and
- How much money you want to put towards each goal.
If you decide to do percentages for your backwards budget you can put 20% of your total income towards your financial priorities. Let’s do an example…
A Backwards Budgeting Example
Let’s say our friend, Kate, has a monthly income is $5,000 and she decides that she wants 20% of it to go to paying herself first, which gives her $1000 a month.
Kate’s immediate goals are:
- Set up an emergency fund with 3-6 months of expenses in it. In this case, Kate will need at least $6,000
- Pay off her $10,000 credit card (which is maxed out)
- Top up her Super Fund
Initially, each month Kate will pay $500 towards her emergency fund and $500 towards her credit card (on top of the minimum monthly payment).
She will set up automatic monthly payment so that these payments come out of her income every month before any other payments.
The best way to teach someone a budgeting method is for them to see it in action.
So, let’s say that our friend Frank makes $3,500 each month after taxes and deductions.
After 12 months, Kate will have the Emergency Fund that she needs, so she needs to find a new home for that $500. At this point, Kate can choose whether to put it towards the credit card or towards her Super. There are arguments for both sides as to whether to pay off debt or start saving first. Do a little research and make your choice. In this case, Kate decides to keep the 50/50 ratio of debt repayment & savings and put the $500 towards her Super.
The End Result:
After all this investment in her future has happened, Kate is left with $4000 a month to live on. This includes mortgage payments or rent, groceries, bills, and all other living expenses.
Benefits of a backwards budget
1. You know exactly where you’re at financially.
The trouble with normal budgeting (and heavens knows I know this well!) is that you’re constantly checking spreadsheets or apps to find out where you’re at and whether you can afford something
With a backwards budget, while you will still have to budget the remainder of your money, you know that a certain amount is going towards your debt repayment and savings each and every month, regardless.
2. You put money into your savings & debt reduction FIRST.
The main reason people don’t save money or pay off debt is that they pay their expenses and then leave the rest of the money in their bank account.
3. When you backwards budget, your savings happen automatically.
You can build an emergency fund relatively quickly because – again – it’s coming out of your income first.
The downsides of backwards budgeting
There are a few things to consider if you decide to backwards budget:
– It is possible that you can save too much money and leave yourself with not enough to cover your expenses.
– It doesn’t work that well for people who are drowning in debt, unless they turn it into a debt payoff method before of a savings method. You can’t have $10,000 in the bank but have $10,000 worth of debt. They basically just cancel each other out and you’re actually still at zero.
– This method can fall a little short if you see an increase in your income. Let’s say you normally make $3,000 a month and your backwards budget plan is to save $500 a month. If your income increases to $4,000 and are still only saving $500, you’ll see a horrible thing happen called lifestyle creep. When you see an increase in income with this method, you must increase your savings by the same percentage.
– If you need to know how your money is doing at all times, this may not be the best method for you. The backwards budget method doesn’t involve tons of tracking and focus on your spreadsheets involved. It’s a set it and forget it type of budget.
If you’ve tried a ton of different traditional budgets over the years and haven’t been able to find one that works, it might be time to try out backwards budgeting.
This budgeting method is awesome and will grow your savings insanely quickly as compared to most other methods.
Would you ever backwards budget? If so, let me know in the comments what draws you to this kind of budgeting.