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Traditional budgeting requires you to itemize all your expenses and then see if your income covers them. With traditional budgeting, the process usually leads to reducing some expenses to make room for others.
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While this method is very convenient and works for many people, there is another way of budgeting that might work better for some people, known as “backward budgeting.” Let’s see what it is and how it can help your finances.
What is retrobudgeting?
Backward budgeting is a fancy way of saying “pay yourself first,” according to Tom Thunstrom, small business finance editor at FitSmall Business.
“Paying yourself first is saving money before you figure out the rest of your budget,” he said. “You would set a baseline goal of how much you’re saving, deduct that from your net income, and then work out the rest of your budget afterward, including housing, utilities, food, etc.”
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Or, in an equation: NET INCOME – SAVINGS = REST OF MONEY IN BUDGET
According to Thunstrom, if you find with this method that the rest of your spending exceeds the rest of your allotted money, you adjust your savings as needed. Or, you can pursue an effective side business to help you earn extra income.
Why it’s effective
Budgeting backwards can help keep incidental expenses, such as your daily coffee, from piling up, Thunstrom explained. “If you stick to a savings goal of $500 a month and spend $120 a month on your extra daily double latte soy whip and you can’t reach your savings goal, you can adjust your daily latte habit to maybe once or twice a week to help you reach your goal.
Some experts also argue that backward budgeting is less stressful and emphasizes saving rather than spending. “However, as with any budget plan, discipline and consistency are needed to make it work.”
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It helps you save towards specific goals
“Using a retrograde budget is a great strategy for making sure you’re investing money in your most critical financial dreams,” said Laura Adams, MBA, personal finance expert on the app. investment, Searcher. “Then you have to live off your remaining income for fixed and variable expenses, such as housing, groceries, transportation, and insurance.”
There’s less to follow
Another advantage of using a retroactive budget, according to Adams, is that you don’t have to keep detailed records of your expenses. “You tackle your most important financial priorities first, then make sure you manage the rest of your income wisely. I’ve always used retrograde budgeting and find it the easiest way to successfully manage my money,” she said.
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You can use the 50/30/20 rule
Adams recommends that if you do retrospective budgeting, you allocate about 50% of your net income to necessities, such as food, shelter, and medical needs. Then you spend about 30% on optional expenses, such as dining out, clothes, vacations, gifts, and other “wants.” Finally, at least 20% of your income is devoted to retirement savings and debt reduction.
It helps to reduce expenses
Reverse budgeting can also help “limit the impulses of human behavior as shown in behavioral economics – that is, people are short-term biased and irrational in their spending,” said Scott Nelson, CEO of MoneyNerd Ltdwhich offers financial advice and education.
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“Instead of having a budget left over and rewarding themselves in the present by buying something, declaring ‘I’ll save next month’, after contributing to the savings, the former have no choice but to be very strict with their budget and completely restrict their lifestyle expenses.”
It helps you focus on long-term goals
Another advantage of this method of budgeting is that it “allows [people] to see the big picture and work towards their long-term goals,” said Ari Shpanya, CEO and co-founder of Loan basea site that demystifies investing and budgeting.
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“Someone who budgets backwards will have a clear idea of what they want to accomplish in the long term. Whether it’s a retirement plan, paying for their kids’ college education, or paying off debt a certain date, retrospective budgeting is the best way to set and achieve monthly goals that will help you achieve your desired long-term goals.And the best part is, it’s even easier than regular budgeting .
You have a clearer vision of your needs
Reviewing your past spending also gives you a clearer view of your recurring needs, allowing you to better plan for them in the future, said Jeff Zhou, personal finance expert and CEO of Fig Loans. “You can assess what expenses you could have avoided and find ways to reduce your expenses and save money.”
You can stick to your budget
Perhaps most importantly, Zhou said, “It helps you stick to your budget because you know your actual pace and you can create a game plan for certain expenses that aren’t regular.”
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