If you’re like most Americans, then I’m guessing the following scenario will sound familiar. You spend weeks looking forward to your next payday, but then the day arrives, and it seems like the money flies out of your account faster than it went in.
You pay your bills, you buy groceries, and take care of all of your necessary budget items. And once all of that is done, you have nothing to show for it. Sure, the bills are paid, but your savings account is just as empty as it was last month.
If you find yourself in this situation every month, you may want to try something called reverse budgeting. With reverse budgeting, you pay yourself first and then use whatever is left over to pay your bills and expenses.
What Does It Mean to Pay Yourself First?
The idea of paying yourself first is a common investing and personal finance strategy. It basically means that you fund your own savings goals first before paying your bills and expenses.
Most people pay their bills on the first of the month and then save whatever little bit is left over. The problem with this strategy is that it doesn’t put any emphasis on saving and makes it harder to meet your goals. This is why 64% of Americans are financially unprepared for retirement.
When you pay yourself first, you treat your own savings like it’s a bill. So you set money aside in your emergency fund and pay into your retirement accounts first and then pay your bills with whatever is left.
An Example of How to Pay Yourself First
Let’s briefly go over a real-life example for how to pay yourself first. For the purpose of this example, let’s say you’re single and have a monthly salary of $4,000.
|20% monthly savings||$800|
|Money left for bills||$3,200|
Most financial experts recommend saving at least 20% of your monthly income. So on the first of the month, you’ll set $800 in savings. This means you’ll have $3,200 leftover every month to pay your bills.
How to Pay Yourself First
Now that you understand the principle of paying yourself first and why it’s important, how do you tangibly apply this to your own life? Let’s look at five steps you can take to implement reverse budgeting and starting paying yourself first.
1. Evaluate your spending
The first thing you’ll want to do is analyze your spending every month. If you don’t have a solid understanding of where your money is going, paying yourself first is going to be much harder.
Plus, tracking your spending can help you identify any areas where you’re overspending. Many people are surprised to learn how much money they’re throwing away every month on unnecessary budget items.
So take the time to sit down and review your budget over the last couple of months. You can use an Excel spreadsheet to track your expenses or a budgeting app like EveryDollar or YNAB.
2. Create a reverse budget
Now you need to identify your short-term and long-term savings goals. Doing this will make it easier for you to come up with a reverse budget.
If you don’t have a six-month emergency fund, that’s going to be the best place to start. If you have a six-month emergency fund, then you won’t have to resort to high-interest credit cards if a financial emergency arises.
You should also spend some time thinking about how much you want to save for retirement. For instance, the maximum yearly 401(k) contribution is $19,500. What would it take for you to reach that savings goal this year?
3. Identify how much you need to save every month
Now that you’ve tracked your spending and created short-term and long-term savings goals, it’s time to come up with a monthly savings plan. Many people recommend following the 50/20/30 budgeting rule.
With this plan, you’ll put 20% of your income in savings, 30% toward your wants, and 50% toward bills and other necessities. It doesn’t really matter what plan you follow, but it’s important to have a monthly savings goal that you stick to.
4. Automate your monthly savings
The best way to ensure that you stick with your monthly savings goal is to automate it. Set up an automatic transfer every month, so you never have to think about moving the money over to savings.
Automating your savings makes life so much easier because you never have to negotiate with yourself over whether to save this month or not. The money is moved over automatically so you may never even see it in your account.
5. Continue to monitor your progress
It takes time to implement any new system into your life, and paying yourself first is no exception. You’ll need to continue to track and monitor your progress along the way. Don’t get frustrated if it takes some time to get it right.
For instance, you may find that when you pay yourself first, you keep coming up short on money every month. We’ll discuss what you can do if this happens in a later section.
The Reverse Budgeting System: Pros and Cons
Paying yourself first is one of the best ways to ensure that you’re making progress toward your long-term financial goals. That being said, there are downsides to any financial strategy you choose to implement.
Here are some of the biggest pros and cons of the reverse budgeting system.
- You guarantee that you’ll hit your savings goal every month.
- You reduce the likelihood of impulse purchases.
- Over time, you’ll have a six-month emergency fund saved.
- The 50/20/30 plan is more flexible than other budgeting strategies.
- Automation makes it easier to save money every month without thinking about it.
- Helps you build the habit of saving for your future.
- This strategy might not work if you have a lot of debt to pay off first.
- It can be difficult for many people to prioritize saving over paying their bills.
- You may feel more stretched financially in the beginning.
How to Find More Room in Your Budget
In theory, paying yourself first sounds very practical and straightforward to implement. But what if you find that after saving 20% of your income, you don’t have enough money left to pay your bills?
If you find yourself in this situation, there are two things you can consider doing. First, you should take a look at your spending and look for any areas where you can cut back.
For instance, let’s say you realize that you’re spending too much money on groceries every month. Is there a way you can reduce your spending in this area? If you spend a lot of money on eating out, could you eliminate this expense from your budget?
Making Extra Income
Of course, there are going to be limits to how much you can cut from your monthly budget. So you should also start thinking about ways to earn additional money every month.
Many people try to earn extra money through a side hustle, but there are a lot of different ways to bring in extra income. You could try selling items you don’t need online, deliver food for DoorDash, or try picking up some extra hours at your job.
The point is, instead of assuming that a reverse budget just won’t work for you, look for ways to be creative. If you’re motivated to make it work, then you’ll find a way.
If you reach the end of the month and find yourself wondering where all of your money went, then you might consider using a reverse budget. When you pay yourself first, you prioritize your own savings over your bills and expenses.
A reverse budget is the best way to ensure that you’re meeting your short-term and long-term savings goals. It may be hard to get started, but if you stick with it, you’ll most likely find a way to make the plan work for you.
However, a reverse budget is not going to be the right strategy for everyone. If you have a lot of high-interest credit card debt, then you may want to come up with a debt repayment strategy first.