Budgeting: Inverted
Cash flow is your financial lifeblood.
Those financially aware control their future with certainty. Those financially unaware leave their future up to chance.
All the tax planning, strategic retirement distribution, risk management, and well-diversified optimized portfolios mean nothing in the face of undisciplined spending.
So how do you control spending?
You create (& adhere to) a budget - but there’s one problem.
Budgets are set up to fail.
The word alone is cringy and sucks the life out of a room like a starving crowd being told their food will take another hour.
But here’s the trick:
Reverse budget.
Traditional budgets look at determining monthly income and calculating expenses. Then after netting the two, you hope (🤞) that you have more money coming in versus going out. If so, you’d likely create a plan to save it. Or, if you’re like most people, you’d just spend it.
Reverse budgeting flips traditional budgeting on its head.
Rather than trying to live within your means, then save the rest, save what you need first, then spend the rest.
This change in perspective puts your goals in the driver’s seat first and your spending priorities second.
Reverse budgeting in practice looks something like this:
Calculate what needs to be saved to reach your goals
If your goal is $2,000,000 in retirement, at 25 this means you have 40 years until 65, growing at 6% with nothing saved currently = $12,924/yr ($1,077/mo).
You can play around with reduce time, rates of return, more savings, or inputting a present value with this future value calculator - HERE
Put savings in the right account
This is likely your tax-advantaged accounts first (Traditional/Roth 401k/403b/TSP & Traditional/Roth IRA, etc.) then brokerage account. Good news in this example is we can just use your 401k/403b/TSP to fund the full amount given it’s less than the 2022 contribution limits of $20,500.
Automate savings
This is key! Fully using your 401k/403b/TSP ensures your savings are automated (as they’re taken from your pay before you receive your paycheck).
If an employer sponsored plan isn’t available, you can automate savings to your IRA accounts and/or brokerage account.
What’s left = new budget
If you bring in $3,000/mo after tax then you have $3,000 - $1,077 = $1,923/mo to spend. This is to include your fixed bills (mortgage, auto, student loans, insurance, etc.) and your variable bills (groceries/dining out, entertainment, vacations, etc.)
Show me your process and I’ll show you the outcome.
Systems > goals
Having a goal is only as valuable as the system you have behind it.
A goal to save $12,924/yr is great; but what systems do you have in place to accomplish this?
Budgeting doesn’t have to be an ever-present painful exercise of constantly reminding yourself to spend less. Through creating a system of automating savings, you achieve effortless discipline.
This isn’t a perfect science but it puts into perspective where you stand today and what needs to be done to get you to where you want to go.
If you find your saving goal is too high, consider the following:
How can you reduce your current spending?
Dig a little deeper to figure out if this is because of fixed expenses or variable expenses then cut the fluff.
How can you live more on less?
What can you do to make yourself more valuable at work (to earn more).
How could you provide more value to your firm in your role (sales, revenue, efficiency, profitability, & service)?
How can you position and negotiate your value relative to wages earned? Less replaceable = more salary (& vice versa).
What skills do your role require that you’re weak in? Learn these skills.
“The unexamined life is not worth living. But the over-examined life makes you wish you were dead.”
Without a practice to maintain the checks and balances in your life, you run the risk of living an unfulfilled life.
Change is the only constant in life but you are always complicit in how you choose to respond to change.
Humans have an incredible ability to adapt to their environment (both good and bad).
This is called Hedonic Adaptation.
There is a diminishing marginal utility to upgrades in quality of living.
Consider buying a new car.
It feels great in the moment, you're excited as driving becomes enjoyable again. You feel the car’s acceleration, turns, and bumps in the road as you notice all its features.
After 6 months or so - you stop noticing.
Why?
Because you’ve adapted to the new stimulus. What’s new becomes mundane.
Most things in life work this way.
Happiness cannot be purchased nor is predicated on perpetual upgrades in quality of living.
Jonathan Haidt in his book the Happiness Hypothesis describes:
“Happiness is not something that you can find, acquire, or achieve directly. You have to get the conditions right and then wait. Some of those conditions are within you. Other conditions require relationships to things beyond you: Just as plants need sun, water, and good soil to thrive, people need love, work, and a connection to something larger”
If you’re finding yourself feeling restrained, conflicted, or deflated as you embark on the path to financial independence, remember:
It’s not budgeting that upsets us, it’s our judgment about budgeting that upsets us.
The person who believes he can, or the person who believes he can’t, is both right.
Change your thoughts & you can change the world.
While you may not be making as much money as you’d like, you can control what you spend.
In this control lies a choice:
Financial virtue or financial mediocracy.
Choose wisely.