Regular budgeting is often not practical
Most people struggle to budget and save money today. With an ever-rising cost of living and easy access to credit, even high earners often have a minimal or negative net worth. In response, some financial professionals recommend that everyone design and follow a detailed household budget for each spending category. If at any point in the month, funds run low in the food department, for example, it’s time to “Switch to “rice and beans,” says savings guru Dave Ramsey. Extreme penny-pinching may work for some, but realistically, very few people can adhere to such a restrictive process. And even if they could, couples may find that putting a magnifying glass to every single expenditure raises pressure between spouses (and children) to the breaking point. While tracking every penny may be helpful in theory, in real life, few do it successfully and sanely over the long term.
Flipping it around
Fortunately, there is a middle ground between penny-pinching and thoughtless spending, sometimes known as “backward budgeting.” Basically, instead of focusing on expense management first and then whatever is left after spending goes to savings (forward budgeting), a couple prioritizes by consistently setting aside enough money to reach their financial goals. Then, whatever is left after savings can be spent as they see fit. As long as the couple is saving enough to achieve their financial goals, how they go about spending the rest of their money is unimportant. If they have enough to marry off and support their kids and fund their future needs like home improvements, health expenses, and retirement, they don’t need to go through a monthly self-audit or feel guilty about how they spend their hard-earned dollars. I thank the brilliant financial writer, Jonathan Clements, for his clear take on this concept which inspired this post.
Save first. Spend what’s left
Here’s what backwards budgeting may look like in practice. The Friedmans* already had a stable income, a home they liked, and some emergency savings stashed away. With the help of a financial advisor, Mr. Friedman had also put in place a 401(k) pension plan and life insurance to cover their longer-term financial futures. At this point, the main financial goals they were concerned with were paying for upcoming simchas and assisting their seven kids after they got married. With the help of a savvy friend, they estimated that by stashing and investing $200 a month per child, they’d have enough to accomplish this mission (with a projected accumulation of $110,000 per child). Therefore, as long as their annual savings quota of $16,800 ($200 x 7 kids x 12 months) was being met, the ratio of how much net income was spent on food vs. clothing vs. vehicles vs. vacations vs. cleaning help, etc. is irrelevant.
Adjust as Needed
Relative to constant budgeting, ensuring consistent savings takes very little time and effort. The Friedmans will set up automatic withdrawals of $1,400 monthly from their checking account into specific investment options. As long as the checking account doesn’t run low and the auto deposits are made, they’re all good! Should they find that their bank account balance is dipping, they then need to make some financial changes that the couple feels are most easily implemented. Whether it’s skipping their weekly eating out, cutting back on cleaning help, adjusting a planned vacation, swapping to a less-expensive car lease, or conversely, adding in some extra income, the specifics don’t have to be negotiated in fine detail. With backward budgeting, as long as $16,800 is headed to savings annually, the Friedmans know they’re headed in the right direction.
Financial “Dieting” may be Required
However, there is a time and place for a penny-pincher budget. Some people enjoy maintaining careful control of their budgets. If so, tracking their money consistently will probably enable them to save and gain additional wealth. Also, those with significant debt or with very limited incomes, whether permanently or temporarily due to job loss or business setback, likely have no choice but to go the harsher rationing route. People in extreme financial circumstances have to track every dollar coming and going while learning how to be as financially “lean” as possible. And finally, most people benefit from tracking all their expenses for at least a while here and there. Thanks to technology, it’s not that hard to do so anymore, and the awareness gained is usually valuable for rich and poor alike.