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A “pay yourself first” money hack: reverse budgeting

A “pay yourself first” money hack: reverse budgeting

There are so many different ways to budget, but we’re intrigued by the concept of reverse budgeting.

21 April 2020 · 4 min read

Although everyone manages their money differently, many of us employ a type of budget, even if we don’t spend time actively managing it.

For instance, some of us pay our bills upfront (when our salary arrives) and then keep what’s left over for spending money. Though this is a fairly passive method, you are essentially still budgeting, because you’re dividing and applying your money.

There are so many different ways to budget. The 50/20/30 budget is a favourite around these parts, but we’re also intrigued by the concept of reverse budgeting. It’s a budget that can keep savings, simple. Keep reading and we’ll give you the scoop.

What is reverse budgeting?

If you really want to prioritise saving money, reverse budgeting might just be for you.

Reverse budgeting is also known as the “pay yourself first” budget.

The basic gist is that when you receive your income, the first item on your agenda is to put money towards your savings. You actually take this step before you pay your bills or your rent, and certainly before you start dealing with spending money, etc.

In some cases, you can actually incorporate reverse budgeting with other budgets. For example, you could use reverse budgeting and the 50/20/30 budget in concert.

How to build a reverse budget?

Let’s build an example of a reverse budget, so you can see how it looks.

The first step is to define your savings goals. Maybe you’re saving for retirement, maybe you’re saving for a house, or maybe you’re simply saving for a holiday. Whatever it is, just define those goals for your own purposes so they’re always front of mind.

For the purposes of this example, let’s say we’re setting our goals in January and your goals are: to contribute an extra $1,200 to our investment account every year; to save $500 for an end-of-year holiday; and to build a $40,000 emergency fund within four years.

The next step is to figure out exactly what you’re working with i.e. your income and your expenses. For the purposes of this example, let’s say you earn $4,000 every month after tax and you pay $1,200 every month in rent and approximately $200 every month on bills.

Now, if you were reverse budgeting in conjunction with using the 50/20/30 budget, you would know that the 50/20/30 budget recommends saving 20% of your salary.

In this case, that means $800 every month.

Now, let’s break down how that fits your goals as described above.

If you want to contribute $1,200 to your investment account every year, you need to save $100 a month. That leaves you with $700 a month to apply to your other goals.

If you want to save $500 for your end-of-year holiday, you need to apply around $42 a month to your savings account. That leaves you with $658 a month for the final goal.

If you apply the entire remaining $658 to your emergency fund, you’ll have saved $7,896 by the end of the year. Depending on where that money is being kept, you may have earned interest on some of that — if it’s in a high-interest savings account, for example. That means you’re probably on track to attain your emergency fund goal within four years.

So, in this case, two of your goals have been reached and one goal is on track.

How to implement your reverse budget

So, now you know how much you have available to apply to your savings and you know how much you need to apply to each of your savings goals.

The next step is to implement your reverse budget.

There are a couple of different ways to ensure you prioritise your savings each month. To make it easy, we’ll apply the names “Manual” and “Automatic” to these ideas.

The “manual” savings approach

The manual approach is probably best for people who don’t get paid on a regular day. For instance, maybe you get paid on the last weekday of every month. So, some months that might be the 30th and others it might be the 31st.

If you use the manual approach, you’d probably log into your bank account on payday every month (or every week or fortnight, depending on how often you get paid). Then, you’d make the appropriate transfers — e.g. $658 to your emergency fund, etc.

Remember, the point of reverse budgeting is to pay yourself first, so you should do it as close to payday as possible. Once you’ve transferred all the various amounts to their respective savings accounts, you can pay your rent and bills and spend the rest of your money as you wish.

The “automatic” savings approach

We’ve talked about easy ways to save money before, but just to touch on the process again, one clever way to ensure your savings goals are met is to set up automatic transfers. This will generally only be possible if you have a specific payday (e.g. the 15th of every month).

Most banks have options within their web banking apps and software that allow you to set up automatic transfers with recurring transactions.

So, if you’re implementing a reverse budget using the example we set out above, you’d set up three automatic transfers, as per the following:

  • $658 every month to your emergency fund.
  • $100 a month to our investment account.
  • $42 a month to a special savings account for your holiday.

And that’s it. Your reverse budget is now in full flight!

One thing to remember

The point of a reverse budget is to prioritise your savings goals. So, you should probably only be thinking about implementing a reverse budget if you are prioritising savings.

This means that if you have any big debt — i.e. credit card debt — you might want to prioritise paying that off first. The ultimate decision on whether you should pay off debt or save money (or do a bit of both) comes down to you and your situation.

Just something to keep in mind when figuring out whether reverse budgeting is right for you.

The information in this article is prepared by Spaceship Capital Limited (ABN 67 621 011 649, AFSL 501605). It is general in nature as it has been prepared without taking account of your objectives, financial situation or needs.

Bryna Howes is the Head of Content & Brand at Spaceship. She's equally obsessive about cinnamon donuts and scouring the web for great reads.

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