Learn How to Pay Yourself First

Why understanding what "Paying yourself first" means and doing it, early in your savings career, can make such a monumental difference long term.

When you have a young family you’re used to being pulled in multiple directions.

I’ve heard it a thousand times. I’ve said it myself, and you’ve probably said it too. “I’d like to start saving for ______(insert goal here) but I don’t make enough money.”

The problem with the above statement is we are waiting until the last step in our budgeting to decide how much to save. We’re following a process that looks something like this:

  1. Pay your fixed needs (housing, car, insurance, childcare…)
  2. Pay variable needs (food, clothing, healthcare…)
  3. Pay additional bills for needs and wants (utilities, internet, streaming subscriptions…)
  4. Spend on other extras (dining out, entertainment, travel…)
  5. Save! (if there’s anything left)

See what happened? Everybody got paid except you! Sure, you received your paycheck, but at the end of the month what was left of it?

What if we made one minor major tweak to the order of how we handed out our money?

  1. Save! (retirement savings, college savings, travel fund…)
  2. Pay your fixed needs (Still really important!)
  3. Pay variable needs (food, clothing, healthcare…also important, shop smart!)
  4. Pay additional bills needs and wants (utilities, internet, streaming subscriptions…anything here we’re still paying for that we’re not using?)
  5. Spend on other extras (dining out, entertainment…based on what is left over)

This time we paid ourselves first! After all, we worked really hard for that paycheck, shouldn’t we be allowed to keep some of it? In fact, we worked so hard that we made a conscious choice on how much of it to keep.

How much to save?

How much to save becomes the next question. For those that start early 10 – 15% towards retirement is often the gold standard. Factor in other goals you may want to save for and 20% of after-tax income becomes a good target for most. The concept of 50-30-20 budgeting where you spend 50% on needs, 30% on wants, and 20% on savings is a popular, simple rule of thumb to get you pointed in the right direction.

What if you don’t have 20% to start putting away right now? That is understandable, particularly if your lifestyle has crowded out dollars for saving. Starting somewhere and increasing your savings rate over time, examining your budget for dormant subscriptions and low value expenses to eliminate, and hiring a financial planner to help create a plan and keep you accountable are among the ways you can get started somewhere, and build to a strong saving rate.  

Start Early

Starting early is important for a variety of reasons. Allowing your investment savings to compound over the longest time possible can make an astronomical difference in the amount you have when you reach into that account to spend it. Notice how the money nearly doubles every 10 years at this growth rate. $1,000 becomes $2,000, which becomes $4,000 in another 10 years, which becomes $8,000 10 years later.

| Initial Investment | Rate of Return | Time Invested | Ending Value | | :--- | :--- | :--- | | $1,000 | 7% | 10 years | $2,010 | | $1,000 | 7% | 20 years | $4,039 | | $1,000 | 7% | 30 years | $8117 |

Compounded monthly. Try it yourself at https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator. Investment returns not guaranteed.

More importantly – the earlier you start the easier it is to get used to a high savings rate, before other income obligations kick in.

What do we mean here? Well, a funny thing happens when you start paying yourself first. What’s left after saving is the money you begin to base your life around. If you’re good at it, you forget the money is even being taken out (we’ll get to that in a minute), and you don’t miss it. Decisions around housing, cars, whether you need the new iPhone right now or if the one you have is good, these decisions all happen after saving, not before. By getting used to paying yourself first early in life, before taking the leap on big decisions like buying a house and raising a family, you are less likely to feel like you have to “scale down” your lifestyle to become a good saver.

Make it easy (automatic transfers)

The best thing about paying yourself first is you can do it without even thinking about it. Automatic 401(k) contributions, direct depositing part of your paycheck to a separate savings account, automatic bank transfers every month to a high-yield savings or investment account are all examples of ways you can put “paying yourself first” on autopilot.

When saving like this is an autopilot you won’t forget to save that month. You’ll be less likely to miss the money because the money automatically moves out of your spending account to your saving account. It’s out-of-sight, out-of-mind until one day when you check the balance of that account and, “Whoa! All that is mine?” (see our chart on the effects of compounding over time, above)

What if I have debt?

Some of you may be reading this and thinking “…but I have a mountain of debt that is keeping me from saving.”

Without a doubt there are times when paying down high interest debt is more important that building savings for a particular goal. However, we can still use the same principles of paying yourself first by moving debt payoff to the top of the order. Once you’ve decided how much extra to paydown each month, the same principles noted above can help keep things on track. Working with someone to decide how much to commit to debt payments each month, finding the wasted dollars in your budget that can serve a better purpose, and putting things on autopilot can help that debt snowball or debt avalanche pick up speed!

Create the perfect plan to pay yourself first.

Putting saving first is a simple, easy to understand way to prioritize savings. It puts you and your family first, focuses in on saving the desired amount each month, and gives you the freedom to spend the remainder where you see fit, knowing that your long term savings is covered. If you need help creating that plan and staying accountable, schedule a quick call with us to learn more about how we help.

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