Saturday, November 4, 2017

The Fine Art of Reverse Budgeting

I thought I was the only weird one doing this until I read an article by Dave Ramsay and confirmed its existence.

I hardly come across people who are doing this in the same way I do, so if you are on the same wavelength with me, give me a high five.

Traditional Saving Method

If you go to a personal finance seminar, you'd tend to find advice that tells you to be frugal, save as much savings as possible to a large extent and then invest the rest.

In that very order.

When I was only starting out wanting to build up capital aggressively, I'd do the same in that order.

Many people budget traditionally by keeping a tab on their day to day expenses and consolidating them with an apps to enable them to track them religiously each month knowing how much you've actually spent in that month.

The idea with doing it this way is you keep focused on each and everything that you've spend under that category and you've become so accustomed to being frugal in your lifestyle that you basically know who you are and what you need.

I think this serves a very good way to track if you are a beginner at saving and would like to see where your expenses go to. However, once you are so accustomed to your frugal lifestyle, there is little point in doing this anymore.




Reverse Budgeting

Reverse budgeting is a concept that I've never thought I would come across but it has suited me rather well in the past three years.

Now, I am not saying that the traditional method of budgeting is bad. Contrary, I think it serves different purpose to different group of people going for different objective. It is important to acknowledge that.

What I did differently with this concept basically is to allocate and tag a fixed percentage of expenses to my income. For instance, if I earn an income of $10,000 a month (hypothetically) and wanted to target a 20% savings rate, then my bucket for expenses would have a budget of $8,000. What I did next is to allocate the primary expenses to these first bucket of budget. These primary expenses such as mortgage loan, groceries, utilities, maid salary, bills are the MUST expenses that I have to incur. The rest would go to the second bucket under discretionary expenses.

Assuming my primary expenses for that month is $5k and discretionary expenses coming in at $2k, I would still have the leftover of that $1k to allocate.

The good thing about this approach is that you can then force yourself to find activities that will increase the value of your life by the need to spend. Now, this may sound weird because every financial experts will tell you to invest that leftover but in my case, I would use that to increase the value of my lifestyle.

Do note that the key is increasing the value of the lifestyle so this is not about spending it recklessly, whichever how you define it. This can be as simple as giving a treat to your subordinate that you feel she deserves or a gift that your spouse has always been eyeing that for. This can also be a travel with your family or extended family member or a dinner meet-up with friends whom you think is important. For instance, in my recent case, I had decided to spend on tickets for Jacky Cheung concerts which my parents have been eyeing for the longest time. I can do this because my budget allows these discretionary expenses.

Whatever it is, you forced yourself hard into thinking ways how to improve your lifestyle. If you have been doing that already, then it's great, but if not, it helps you to achieve a greater lifestyle in a discretionary manner.

You don't necessarily have to spend to increase the value of your lifestyle but having that extra money makes things easier, at least in my case.

Step 1 - Allocate a savings percentage rate that you would like to achieve.
Step 2 - Deduct the MUST primary expenses to the first bucket of expenses.
Step 3 - The rest goes under discretionary expenses and you are free to spend!
Step 4 - Find an activity that increases the value of your life with the rest of the budget you have.

For every good thing, I feel it is important to also highlight the downside.

The downside with this approach is you would need to be flexible with adjusting your discretionary lifestyle. Many times, we take things for granted that we become inflexible in adjusting.

For instance, if you suddenly found yourself being retrenched or taking a paycut to say $8k a month, then using the same 20% savings rate that you set, you'd also need to adjust down your budget and subsequently your discretionary expenses. Remember, the primary expenses are mostly there to stay so the only variable you can play here is adjusting your lifestyle and this can be difficult to some.

Still, I think if you are disciplined at the start by being able to allocate things appropriately to the budget, I think you are considered a discipline person. Otherwise, you are going to be screwed nevertheless.

Final Thoughts

It is important to realize that there is no one fixed for all method in budgeting. 

There are many ways that you can explore and see which that would align with your objectives.

What came out for me with this reversing method that I use is that I am still able to save a decent percentage for my income (in this case 20%), build up my emergency, invest the rest and still grow my wealth in the right direction. Most importantly, I had also increase the value of my lifestyle and am much happier this way.

This is just a personal sharing which may or may not suit everyone's needs.


Thanks for reading.

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12 comments:

  1. Huh?? When I started out 20-25 years ago, almost all popular literature on personal finance advocated first setting aside a fixed percentage or amount for savings & investments. This was known as "paying yourself first".

    Not sure about now though ... maybe things are different??

    ReplyDelete
    Replies
    1. Hi Anonymous

      Paying yourself first makes most sense especially for beginners because they tend to lose control over how much they are able to allocate. Over a number of years, I think it would fine to tweak the model a bit once you get the system going.

      Delete
  2. Good read! High-5! I refer to it as macro budgeting - because it gives you the flexibility to shift your expenses around within your allocated budget - less fixed expenses.

    ReplyDelete
    Replies
    1. Hi Financial Monkey

      Yeah, macro budgeting I think makes a perfect phrase because it tends to look over the bigger picture without going into very detail micro specific items, which by in large works well anyway.

      Delete
  3. Hi Brian,

    As always, great write up.
    Was just wondering, how do you allocate the 20% that you have saved? ie. How much of the 20% goes into Emergency funds, investments, etc?

    Thanks.

    ReplyDelete
    Replies
    1. Hi Anonymous

      Thanks for your kind words.

      My 20% that I saved will usually go to my investment directly, either in the form of warchest or allocated directly to specific companies. My emergency funds are full and ready and I do not have specific anywhere else that I'd like to allocate other than growing my portfolio at this time.

      Delete
  4. This comment has been removed by the author.

    ReplyDelete
  5. HIGH FIVE!!

    As a Singaporean based in HK for the last 4 years, I was somewhat forced to use this method since rent already takes up 25-30% of my month salary. It was very difficult to "Save as much as possible because rent already takes up quite a hefty portion of income". On average, HKers typically allocate 30-50% of monthly salary on rent alone. Having a roof over our head is a priority, followed by primary expenses. This method has served me tremendously well and I know that once I relocated back to Singapore where rents are cheaper, i've got more $ allocated to step 3-4, and also increase my % of savings. Overtime, i also learned the art of cheap thrills and constantly sought to find activities that provide maximum value with minimum cost.

    Again, HIGH FIVE YO.

    ReplyDelete
    Replies
    1. Hi just curious. Is your salary very high otherwise why work in HK paying high rent?

      Delete
    2. Got a fairly good salary increment (from a low base) when relocated from Singapore to Hong Kong despite having to pay high rent. My take is that the incremental savings from being posted back to Singapore after my HK stint would make up for the loss of savings having to pay high rent in HK. Suffer now, enjoy later.

      Delete
  6. My philosophy is to manage my finances like a biz. First cut costs aggressively. Eliminate unnecessary expenses or find cheaper alternatives. Save and invest the rest. Dont really have a budget for discretionary expenses such as travelling costs.

    I dont review my expenses at a very detailed level as it is time consuming.
    If I know roughly I spend too much this month then next month I will spend less.

    Overall I simply follow a strict financial discipline to control expenses.

    Refer to my blog for more details
    My-radical-thoughts.blogspot.com

    ReplyDelete
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