Sometimes the simplest phrases can change the way of doing things better.
Pay yourself first is one such financial term that may alter how you manage your money thus far. This phrase embodies financial wisdom that can maximize your ability to build wealth. Although simple, it requires you to take a few steps, leading to long-lasting benefits.
What Does “Pay Yourself First” Mean?
First and foremost, paying yourself first is a reverse budgeting strategy that prioritizes consistent savings. Rather than saving money after paying for your needs and wants, you are setting it aside for your financial goals before spending a dime.
For some of us, having money in our pockets seems to burn a hole in it, and we feel like we must spend it. When you finish your paycheck first, you can spend more on your discretionary items, leaving very little in savings. By adopting a mindset geared toward saving money first, you are changing your habits for the good of your finances.
Recognize that saving money is not an end but a means to build wealth by investing in your financial future. When you pay yourself first, your income will go to a predetermined amount to savings and retirement accounts before paying your bills. Of course, your bills don’t go unpaid, but savings will become an essential line item on your budget.
We’re Not Savings Enough
The US personal savings rate measures personal savings as a percentage of disposable income left after spending money and paying taxes. The latest rate dropped to 6.4% in January 2022, the lowest since 6.0% in December 2013.
American savings rates were unusually high at 33.8% in April 2020 due to pandemic-related lockdown measures and high unemployment, which kept spending down. Low savings rates mean people need to be saving more for emergencies or retirement, and they need to put themselves first.
According to Bankrate’s Emergency Savings survey, more than half (51%) of Americans can’t cover three months of expenses for an emergency, and one in four (25%) have no emergency fund at all, up from 21% in 2020.
Workers have saved a median of $93,000 in all household retirement accounts for all age groups. That would be an excellent start for those in their 20s, but they may need more for those closer to retirement age. A recent study by Transamerica Center For Retirement Studies reports that fewer than one in four are “very” confident that they will be able to retire with a comfortable lifestyle.
It’s Time To Put Your Finances In Order
It is an excellent time to pay yourself first so that you set aside money for unexpected emergencies and retirement savings.
Paying yourself first doesn’t mean you should ignore your religious beliefs, as part of your savings should go to tithe.
This bellwether term, “pay yourself first,” is financial wisdom coined by George S. Clason, author of one of my favorite books, The Richest Man In Babylon.
Here are three quotes from Arkad, the fictional Babylonian character, a poor scribe who told parables and gave advice based on how he became the wealthiest man:
“Start thy purse by fattening.”
“Every gold piece you save is a slave to work for you. Every copper it earns is its child that also can earn for you.”
“A part of all you earn is yours to keep. It should not be less than a tenth no matter how little you earn. It can be as much as you can afford.”
His advice is sound, asking that you save at least 10% even if it means sacrificing your wants and making your savings work for you by allocating your money to investments. The last step is to increase your savings as you earn more money. Let’s walk through the four steps which ask you to consider your financial goals, evaluate your budget, and determine your savings goals for your priorities.
Pay Yourself First In 4 Easy Steps
1. Set Financial Goals
Determine your financial goals and be as specific as possible. Bad habits like relying on bank overdrafts and credit card spending are troubling behaviors to eliminate quickly. It may be an excellent time to establish a new habit or replace an unwanted one.
By paying yourself first, you prioritize your savings, directing money toward your emergency funds, retirement accounts, and where most needed. It is easier to avoid overspending when your goals are front and center.
By establishing your goals individually or with your partner, you can make sure you are staying on the path you most desire so that you can buy your dream house, retire in comfort, and avoid the burden of too much debt.
2. Evaluate Your Monthly Budget
Your monthly budget is an excellent place to start. Review your monthly income and expenses before determining how much you can save. Distinguish your fixed living costs from variable costs, providing a sense of your discretionary spending and what areas you can reduce.
There are different budget methods. You can use an excel spreadsheet or pick among several good budget apps. When you review the budget, there may be prominent places where you can improve to eliminate unnecessary costs, such as too many streaming services or dining out too much.
A helpful rule of thumb is the 50/30/20 budget, helping you allocate each paycheck.
Essentially, you are dividing your after-tax income into three buckets:
20% To Savings And Debt Prepayment
Let’s start with the savings bucket first, and start small with 5%-10% of your after-tax income going to savings, and work your way up to 20% of your take-home pay going to savings and debt repayments, especially if you are carrying a substantial credit card balance.
Your savings can pay down debt, feed an emergency fund and make investments. This amount is building your financial future. If you have significant debt obligations, a higher percentage should go into this bucket to reduce it. You are likely saving money by eliminating the excessive interest costs you carry on your balance when paying off your debt.
50% For Basic Needs
After saving money, paying for your basic needs is your priority. Housing is the proportionally most considerable amount of your basic needs and includes rent or mortgage payments, utilities, groceries, car loan payments, minimum debt payments, and other monthly fixed expenses. About 50% of your earnings go toward your basic living needs.
30% For Wants
After the above priorities, allocate 30% for wants or desires. This allocation is for discretionary or flexible spending for entertainment, vacations, and shopping. After your preferences, the remaining amount is for your desires. Your discretionary spending may take a hit if you have excessive debts to eliminate. Avoid overspending on your credit cards. Keep your wants at manageable levels.
A Word About Your Debt
Saving money is your primary goal, but savings and achieving your financial goals may prove elusive depending on your debt type.
You will need to look hard at your credit card debt state. Issuers charge a substantially higher rate when carrying large credit card balances than a mortgage or a car loan. Eliminating this debt first should be a priority.
The average US credit card balance in 2021 was $6,270. With an average interest rate of 16.17%, your card balances will outpace any return you earn from savings. These onerous amounts are challenging to eliminate. You may need a professional to help you with debt relief or consolidation.
All or part of your intended savings should pay down this costly debt until you can firmly eliminate this threat to your finances. Use cash or a debit card and reduce your discretionary spending until you aren’t carrying a card balance. At the same time, wait to use your credit cards until you can ultimately pay the monthly balance.
3. Automate Finances With Your Savings Goals
You will want to determine your savings goals based on your short-term and long-term plans. Ask yourself what you can comfortably save from each paycheck.
Start with a smaller amount if that is more comfortable, but increase to a 20% percentage and distribute the amounts automatically to designated accounts. Saving money in some of these accounts provides tax advantages: your retirement accounts, 529 college savings plans, and health savings accounts (HSAs).
Depending on the particular account, you can automate your finances systematically. You can move money from your paycheck through your employer’s payroll department to your 401K plan or your checking account, where you can arrange specific amounts to go to a particular bank or investment account priority.
It is easy to set up direct deposit by filling out a form at your bank so that checks you receive (e.g., payroll, government, or dividend checks) go to your designated areas as automatic transfers like checking, savings, sinking funds, or money market account.
Most importantly, you can predetermine your savings commitments to essential savings accounts and systematically have the amounts withheld from work or transfer money from your checking account that receives the direct deposit. Pay yourself first means funneling your paycheck to contribute your savings to the below accounts:
Employer Retirement Plans. You fund your 401K with pretax dollars, deferring taxes until you withdraw your retirement money. Direct your payroll department to withhold a certain amount from your paycheck to go to your 401K, 403B, or 457 employer retirement-sponsored plans.
Let’s say you want to contribute 5% of your annual salary of $60,000 or $3,000 per year ($250 per month). If your employer has a match contribution of your amount, typically 50% to 100%, they would add $1,500 to $3,000 as added annual income.
Establish your traditional IRA/Roth IRA at your bank, brokerage, or investment firm, and transfer money to this account from your checking account monthly or per paycheck. You make after-tax contributions to a Roth IRA, in contrast to 401K and traditional IRA accounts.
Taxable investment accounts. Move money directly from your checking account to taxable investment accounts or from your savings account.
Bank Savings Accounts
Establish an emergency savings account. Ensure your emergency fund can cover at least three to six months of essential living costs. When you use money from this fund, make sure to replenish the amount.
Various Savings Accounts. Bank savings accounts, such as high-yield savings, money market accounts(MMA), and sinking fund accounts, allow you to tailor for specific goals like saving for vacations, furniture, a down payment for a car, or buying a home.
4. Boost Your Savings
When you organize the distribution of your initial savings amounts, review periodically with an upward bias to saving more money from:
Elimination of streaming or unwanted services or negotiate down some of your costs.
Make more income from salary hikes, bonuses, or new income streams.
Sell some of your things through the tag or garage sales.
Make your savings work for you and allocate more money to your retirement and investment accounts.
Pay Your Bills On Autopilot
By automating your finances, you can direct your savings to specific accounts without having a chance to spend the money. This action will help you limit spending temptations and other undesirable behaviors like paying a bill late.
Our focus is on savings here, but most vendors have bill pay services to streamline the process so that you can pay monthly bills such as rent, utilities, mortgage, other loans, and recurring payments. Alternatively, you can set up automatic debit payments, which allow the company to take payments from your bank account. You can talk to your bank about recurring bill pay and automatic debit payments.
Pay off your credit card bills in full each month rather than just paying the minimum amount, which results in the issuer charging you excessive fees on the remaining card balance.
Paying yourself first means contributing more to savings and investments while spending less. By adopting a mindset geared to saving money first, you are changing your habits for the good of your finances, paving the way for you to build wealth more successfully.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.