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Re-Inventing Personal Finance

16 April, 2018

Something else that might appear to have changed, but really hasn’t: Personal finance. When you get to its essentials, the issues of personal finance today are the same as they’ve always been: to protect one’s assets (both human and material), to save for the future, and perhaps to leave a legacy for those who come after us.

But some people, especially those with a marketing bent, want to put a different wrapper on timeless ideas and present them as “hidden secrets,” or “amazing breakthroughs!” And thus, we have “Reverse Budgeting.” 

“What is Reverse Budgeting?” (Aw, you probably know.)

Reverse Budgeting is a strategy that addresses two fundamental issues in personal finance: The need to save for the future, and the psychological challenges that accompany that task.

If everyone understood their personal finances as a business (which it really is), and if we saw ourselves as business owners (which we really are), then we would do what good business owners do: prepare a budget to analyze costs, set limits on spending, and maximize profits. And once completed, we would live by it, at least until circumstances proved the budget needed to be adjusted.

But most of us resist this level of detail and management. As Peter Lazaroff, a Wall Street Journal personal finance writer says, “Traditional budgeting forces you to make every decision as if you live in a spreadsheet. But guess what? You don’t live in a spreadsheet.”

With Reverse Budgeting, you simply decide how much you’re going to save each month or pay period, and have that amount automatically deposited – into a savings account, retirement plan, mutual fund, insurance policy, whatever. And then you can spend the rest of your income however you want.

Reverse Budgeting is, to use present vernacular, a way to “hack” our human tendency to be overwhelmed by details and the tyranny of the urgent. It removes the angst that comes from making, keeping, and constantly adjusting a budget, and makes the most important thing – saving for the future – as easy as possible.

Reverse Budgeting in History – From the Ant to the Savage Circles

There is a financial planning organization that, according to its webpage, claims to have invented Reverse Budgeting. Saying their innovation was “born” out of a desire to see their clients spend their money “without feeling guilty or irresponsible,” the firm has even trademarked the phrase Reverse Budget™.

But Reverse Budgeting is truly nothing new under the sun. It has ancient roots, going back at least to Solomon. Except a marketing guru of his day might have called it the “Ant Plan.”

Aesop was a slave and storyteller believed to have lived in ancient Greece around 600 BCE. One of his most familiar fables is “The Ant and the Grasshopper,” about an ant who saves diligently while a happy-go-lucky grasshopper sings and plays, only to face starvation when winter comes and he has nothing stored up to eat. Even though ridiculed by the grasshopper for his reluctance to enjoy the moment, the ant overcomes distractions to focus on the most important thing: saving for the future.

Of course, in agrarian societies, “the future” wasn’t 30 or 40 years in the distance; it was each winter. You didn’t save for retirement, you saved to make it to the next harvest. But even in “modern times,” Reverse Budgeting has had a previous incarnation, under a different name.

From the early 1960s until his death in 1993, John Savage was a prominent figure in the financial services industry, known for simple diagrams that explained the fundamentals of personal finance. One of Savage’s best-known illustrations was the Two Circles. 

Savage would draw two circles side by side. In the circle on the left, he would write “spend” and underneath write “save.” In the circle on the right, he would reverse the order.

“There are two kinds of people in the world,” Savage would say. “Those that spend first, then save what is left over. And those that save first, then spend what is left over.” And after a dramatic pause, he would ask, “Guess who are the better savers?” Two circles, three sentences, one conclusion, mic drop. That was Reverse Budgeting, 1970s-style.

 

New Versions of Old Truths Are Okay

Even if it’s not really new, it’s probably good that Reverse Budgeting has been introduced. Most of us need regular reinforcement, to keep hearing the old stuff we already know. And sometimes the best way to do that is to make what seems old look like something new. Because right after Solomon noticed there was nothing new under the sun, he also said:

There is no remembrance of former things; nor will there be any remembrance of things that are to come by those who will come after.

The Ant Plan, the Savage Circles, and even the Reverse Budget, will probably be forgotten by the next generation, only to reappear as another “new” idea. But innovation is just a different iteration of the same good idea.

 

Making Saving Habitual (it might require a budget).

William James, a late-19th century philosopher often referred to as the “father of American psychology,” is someone of whom there is little or no remembrance today by most Americans. But James had a great respect for the power of habits:

“All our life, so far as it has definite form, is but a mass of habits – practical, emotional, and intellectual – systematically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be.”

Of course, since there’s nothing new under the sun, James was echoing back to Aristotle, who said:

“We are what we repeatedly do. Excellence then, is not an act, but a habit.” 

By starting with saving and making it automatic, Reverse Budgeting provides a practical, emotional and intellectual structure for wealth accumulation to become habitual. And once established, there’s only one thing that might derail this habit: an unrealistic saving target.

A decision to save 20 percent of take-home pay is admirable. A decision to save 20 percent, then finding it doesn’t leave you enough money to pay your basic living expenses, let alone any incidentals, is foolish, and going to fail.

Which is why, at least once, you should construct a realistic budget, if only to see how much you can save habitually. After this sustainable saving becomes a habit, it can be gradually increased – maybe without making another budget.

To restate the obvious one more time: There’s nothing new…well, you know the rest. The basics of life, and personal finance, don’t change. And habits shape your destiny.