Will cutting out that $4 morning coffee really help you reach your goals? You’ll often hear the Suze Ormans and Dave Ramseys of the world harp on these small changes as a way to improve your chances of achieving your goals. While it does help to cut down on trivial spending, it also causes people to focus on all the things they shouldn’t do rather than what they should do. That is why we suggest considering a technique called reverse budgeting as an alternative. Reverse budgeting involves identifying your desired end goal or outcome, and then determining the costs associated with achieving that goal. Instead of starting with a set budget, and figuring out how to cut out as many things as possible to maximize savings, reverse budgeting focuses on your desired savings rate, for example 20% of income, and on saving that amount out of your paycheck up front. This allows you to spend the remaining funds as you please, without the anxiety behind every purchase. In other words, reverse budgeting focuses on starting with the desired result and working in reverse to determine the amount of money required to achieve that result.
The reverse budgeting process typically involves the following:
1. Identify your goal or outcome: This could be anything from a set savings percentage needed to retire, to saving for a down payment on a house, to starting a business, or taking a dream vacation. 2. Determine the cost or percentage of income needed to achieve the goal: Once you have identified your goal, you will need to determine the total cost of achieving that goal. For example, if your goal is to purchase a home, you would need to save the required down payment, and any closing costs including the real estate agent’s fee. 3. Create a plan to achieve the goal: Once you know the cost of achieving your goal, you can create a plan to make it happen. This involves setting a timeline for when you want to achieve the goal, automating the desired level of savings needed to reach it within the set time period, and identifying any potential obstacles or challenges that may arise along the way. 4. Adjust your savings accordingly: With a clear understanding of the cost of achieving your goal and a plan in place, you can then adjust your savings amount accordingly to accommodate any changing expenses associated with achieving it.
Reverse budgeting can be a useful tool for anyone who wants to pursue a specific financial goal, or a specific desired level of savings, as it allows you to focus on the end result, rather than the limitations and restrictions of your current budget. It is also a psychological tool that can be used to help you enjoy your remaining income, without feeling guilty about buying that $4 morning cup of coffee. By working backwards from your desired outcome, you can create a plan that allows you to enjoy your money, while working towards your goals.
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
Comments