Financial planning is one area in which most people could use some guidance from a trustworthy and qualified professional. Over 2/3 of Americans fail to keep a regular budget and resort to credit cards more often than they should. But why is keeping a budget so easy on paper and so hard in reality?
Is traditional budgeting the only way to take control of your spending and saving habits? While maintaining a budget in the traditional sense is beneficial most people find it difficult to do. There is an alternative method that can make the idea of budgeting more palatable and you won’t need complex spreadsheets, websites, or piles of receipts. This method known as “backward budgeting” has helped many people increase their savings and achieve their financial goals. There are three simple elements in backward budgeting:
• Understanding why traditional budgeting doesn’t work for everyone
• Changing your mindset on how spending/saving works
• Using backward budgeting towards financial success
Understand why Traditional Budgeting Doesn’t Work for Everyone
Most people have a hard time tracking and saving money, but the issue is more prevalent than you probably realize. The average savings rate in the US is just 5.5% of net income and for most people the lack of savings results in a drastic reduction in their lifestyle once they retire. Another startling statistic is that nearly 7 in 10 Americans have less than $1,000 in a savings account. Here are the three main reasons why traditional budgeting doesn’t work for everyone:
It’s Time-Consuming and Difficult
Recording all of your spending habits sounds like a very daunting task, and most people are only concerned with the bottom line. As long as they can pay their bills they don’t worry about where their money is going. Reviewing bank and credit card statements is nobody’s idea of a good time, so people tend to put it off for as long as they can. Although ultimately the longer you put it off – the more time it’s going to take to go back and date all of your expenses which results in people never doing it.
Expenses Fluctuate Month-to-Month
In a perfect world, your expenses won’t change from one month to the next. Realistically things are much more different and unplanned expenses come up every month, sometimes even every week constantly stretching your budget. Some of the most prominent unplanned expenses are emergency medical care or car repairs both of which will strain your finances, especially if you don’t have an emergency fund established. If you don’t plan your budget with some degree of flexibility, you’re going to find it very difficult to stick to one.
Even Websites Have Flaws
There are many sites that offer tools to help you track your spending but the problem is they can appear to be very complex. This puts people off especially if they’re already confronting the fact that they’re overspending. Additionally, while they offer some benefits, they are far from perfect. One of the biggest shortcomings is the need to manually input all cash spending – if there’s no paper trail the tools can’t track the expense. Attempting to recall every cash transaction you make can be frustrating but without the information the tools are unable to reconcile the budget correctly.
How to Change Your Mindset on Spending/Saving
Backward budgeting is all about changing the way budgets make you think about money. Traditional budgeting allows you to track all your expenditures into detailed categories, then focus on where you can make changes to increase your savings. But this means you think about spending first before savings what’s left over.
You should be doing the exact opposite
When you focus on saving money first and spending what’s left over – you rearrange your priorities altogether. This change in mindset seems small, but it will change your entire outlook on saving. It’s all about prioritizing. If you make it about saving first and spending later then you’re forced to adjust your spending around your savings – not the other way around. This will set you up for success with whatever your financial goals may be.
Budgeting Backwards: Your Way to Financial Success
Now let’s look at how backward budgeting actually works. You need to follow several steps to implement this strategy in your life, and unlike budgeting, this strategy takes less effort to plan. The first thing you need to do is find out what your current living expenses are, something many people underestimate. There is no need to tally up each itemized expense, but simply back into it:
Net Income – Savings = Living Expenses
If your net monthly income (income after taxes) is $5,000 and you’re saving $500 per month towards your goals – that leaves you with living expenses of $4,500. If you want to increase your savings to $1,000 then you must decrease your expenses to $4,000. As long as you know you’re saving enough, you can spend the rest on whatever else you want–eating out, vacations, etc. It gets easier as you go as you don’t have to track each individual expense. But how do you achieve this?
Establish an Emergency Fund
You should establish and emergency fund of at least a couple thousand dollars. This allows you to continue to save even when unexpected expenses come up. If you plan for those unexpected expenses, you won’t be forced to dip into your savings account and deplete all of that hard work.
Make it Automatic
One easy way to help yourself save more is to set up automatic transfers to your investment accounts and match them to the days of the week you get paid. If you can get into the mindset that the money was never there to spend – then you won’t spend it. Another option is to set up automatic deductions from your pay check into your employer-sponsored retirement accounts. The money will be saved before you even have a chance to spend it (while reducing your taxable income!). Save first, and spend later.
Wrapping It All Up
The real purpose of budgeting should be about tracking where your money is going so you can make better decisions with it. If you budget regularly and find out you are overspending on dining out for example but then never did anything about it then you aren’t effectively using the information you gathered and are perpetuating the cycle of overspending. That’s why backward budgeting offers a better approach. It flips the strategy on traditional budgeting, from a task you dread to a useful tool that helps you understand and manage the big picture.
When you save enough for your goals, then you gain the financial freedom to spend the rest of your money on anything you please.
Having said that, backward budgeting can be tricky. As with everything else, it takes discipline and getting used to. Although automating it and keeping an emergency fund are the first steps to getting it right. Trying out budgeting backwards can be the key to enjoying your life, having fun and spending your money on whatever you want if traditional budgeting isn’t working for you. All while meeting the savings goals that you established.