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Most budgets are built around your expenses. But the pay-yourself-first method flips that approach on its head.
'Pay yourself first' is a reverse budgeting strategy where you build your spending plan around savings goals, such as retirement, instead of focusing on and expenses. This prioritizes savings, but not at the expense of necessary expenses like housing, utilities and insurance.
Use these steps to set up your own reverse budget.
To make this budget successful, you’ll have to prepare. Rachel Podnos, a certified financial planner in Washington, D.C, recommends reviewing your typical spending by pulling up your bank and credit card statements.
“Do the math and start conservative,” Podnos says. “You can always increase [your savings contributions] later. You don’t want to risk an overdraft or bounced check or something like that.”
Pinpoint a realistic amount using the approach. This method allocates 20% of your monthly income to savings and debt repayment, 50% to necessities and 30% to wants. With a $3,400 monthly income, for example, you’d reserve no more than $680 for savings and debt repayment, $1,700 for needs and $1,020 for wants.
Make a list of your savings goals. Saving for retirement and building an emergency fund should be your first priorities, followed by other goals, like travel, new appliances, or a house.
You can contribute a small amount to each goal or pick a couple to focus on first. Decide how much you need to save to reach those goals and what how much you can afford to sock away each month, using the 50/30/20 guideline.
So let's say your monthly income is $3,400, for example, and each month you want to save $150 for your emergency fund, $200 for retirement and $100 for a new motorcycle. Set aside that $450 first, then use the remaining $2,950 toward other costs, such as rent, groceries, utility bills and loan payments.
Note: The 20% toward savings and debt repayment category includes an emergency fund and retirement contributions. Savings goals, such as travel, a wedding or that new motorcycle, would count toward your needs or wants.
Ideally, you have enough money coming in to and savings goals. But if you find yourself coming up short, look for ways to scale back. That might mean focusing on one savings goal at a time, or finding ways to trim expenses from your needs and wants categories, or all of the above. You can also explore .
The pay-yourself-first budgeting method is low maintenance compared with others, such as . It doesn’t require you to categorize every expense or keep a detailed record of your spending.
It can also help you focus on the big picture and reduce impulsive purchases. When people save first, they have less money to spend and tend to use the remainder on things they need or value.
Automation is a simple way to pay yourself first. Set up contributions from your pre-tax salary to your , if you have one. And use an or log onto your bank’s website to arrange automatic transfers from your checking account to your savings account or IRA.
Prioritizing savings over other goals might not always be in your best financial interest. For example, if you have — such as a high-interest credit card balance — we recommend tackling that before saving up for a vacation or a new car. Podnos suggests classifying your debt payments as savings to help resolve that issue.
Paying yourself first is a great option if you prefer a hands-off or don't want to feel as though you’re budgeting at all. Remember to automate your savings for an easier experience.
If you need more structure, consider a more involved budgeting method such as the , which portions out your entire income toward all of your expenses at once.