Few principles are more important in personal finance than the concept of paying yourself first.
You may have heard of this term and not understood it. Or, you might be struggling to save money every month and need to rectify that.
If you need to manage your money more efficiently, this guide explains how to do that and grow your wealth.
What Does it Mean to Pay Yourself First?
The pay yourself first strategy is exactly as it sounds. You put aside funds from each paycheck for specific financial goals before you spend money on any monthly bills.
In essence, it’s viewing yourself as a bill that you must pay.
This may sound difficult to do. Fortunately, thanks to automation, it’s easy to transfer funds to savings accounts, Roth IRA accounts, and more.
The key idea is that this is done before paying for any obligations or wants and needs. In effect, it’s reverse budgeting by taking care of yourself first before anything else.
If you participate in your employer-sponsored 401(k), it’s a similar idea. You make an automatic contribution every pay period to your retirement account, and this is made before taxes are withdrawn.
Steps to Take to Pay Yourself First
If you want to try the pay yourself first budgeting style, it is relatively simple to do. Here are the steps to follow in order to grow your savings and net worth.
Know Your Budget
Knowing your finances inside and out is essential to make this budgeting philosophy work. Before you get started, you must know your monthly income. You must also create a list of bills.
If you’re new to this idea, read our guide on how to create a budget. To begin, you want to track your spending for a month.
Regardless of the amount you spend, write it down. Not completing this step will hinder your ability to make informed decisions.
Writing down your spending will give you an idea of your living expenses and where your money goes each month. That is the foundation for creating a spending plan and budget for your money.
If you find that you’re living paycheck-to-paycheck and need to spend less, look for ways to cut expenses. Our guide on how to lower your monthly bills is a good place to start.
Budgeting can be cumbersome if you’re a novice. Don’t let that hold you back. A budgeting app like You Need A Budget (YNAB) is a terrific resource to help you automate the process.
YNAB connects with your bank account, so much of the work is done for you. All you need to do is analyze what you find.
If you determine that YNAB isn’t for you, there are other choices to manage your money. Read our guide of the top You Need A Budget alternatives to oversee your finances.
Once you know your budget, it’s time to move to the next step.
Establish Your Goals
Objectives are essential to have when trying to improve your finances. Goals are the fun part of budgeting. As you look at your finances, you want to consider your short and long-term goals.
Personal finance is personal, so your goals should be specific to you.
Here are some common goals people have:
- Building an emergency fund
- Saving for retirement
- Having money to buy a house or car
- Saving for vacation(s)
- Saving for a child’s college fund
Your goals might be different, and that’s ok. As you list your savings goals, determine the amount of money you want to apply to them each month.
These amounts put meat on the bones of your goals and give you an action plan.
Automate Your Saving
Now that you have your savings goals, you need to make the process simple. Again, the idea is similar to saving in your 401(k).
You want to transfer funds automatically from your checking account to savings vehicles. This can either be done every pay period or once a month.
Manually transferring money is ok. However, when you automate your finances, you ensure that you won’t miss making regular savings contributions.
This is key to reaching your goals. It also helps streamline your spending.
Most banks allow you to automate savings for free, so there’s no reason not to do it.
Create Multiple Accounts
Paying yourself first typically requires you to have multiple savings accounts. Leaving all of your money in a checking account makes it easier to spend, and you earn no interest on your cash.
Multiple savings accounts might sound overwhelming, but it’s not a lot of work. It actually makes your finances simpler to manage.
For example, having your new car fund separate from your travel fund makes it easier to track progress. Plus, it lets you see exactly what you have for each goal.
Many banks let you have multiple accounts at no extra charge. Online savings accounts, like those at CIT Bank, are a perfect option.
They pay more competitive rates, often have low minimum account balances, and charge little to no fees. You can even title accounts so that you know what each one is for.
Our family has numerous savings accounts, and we find it’s a helpful way to manage our goals.
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Have Your Employer Help
Your employer is an excellent resource for automating your finances. They likely already do it with your 401(k), and they can implement a similar strategy with your savings accounts.
Many employers allow you to transfer chosen amounts from each paycheck to a different account.
For example, if you want $100 from every paycheck in your travel fund, they can send those funds to your devoted account.
This is usually done at no charge, and it is easy to establish. You often just need to provide the routing and account number at your bank. Then, your employer will do the rest.
Adjust When Necessary
You don’t want to set it and forget it when you pay yourself first. A regular analysis is essential when managing your finances, and it’s particularly important when so much is automated.
If you find that you’re unable to make monthly payments without pain, you may need to readjust your savings amounts. You can also look for ways to cut discretionary spending to alleviate stress.
Additionally, if you’re working to boost your income, you can adjust upwards to save more.
You will want to monitor progress every month when first starting out to ensure success. Don’t be afraid to make small tweaks to get everything right.
After you become more comfortable with automation, review your finances quarterly or semi-annually. This lets you stay on top of things without constant management.
Pros and Cons of Paying Yourself First
There is a lot to consider when trying reverse budgeting. Here is what to keep in mind when paying yourself first.
- Low maintenance
- Excellent resource to grow your net worth
- Automation is helpful to your budget
- Prioritizes saving over everything else
- Challenging if you live paycheck-to-paycheck
- You may overlook other ways to optimize spending
- Might be difficult if paying off lots of debt
Overall, the pay yourself first philosophy is a good tool to improve your net worth.
Should You Pay Yourself First if You’re Paying off Debt?
High-interest debt can be destructive to a budget. You may feel that it’s impossible to pay yourself first when in debt. That is understandable, but every situation is different.
Dave Ramsey, for example, promotes only building a small emergency fund of $1,000. Then, you focus everything on debt.
That isn’t bad, per se, but it overlooks the importance of growing savings.
If you need to put saving money on hold for the short-term, such as a year, you likely will be fine doing so. Anything beyond that is often not advisable.
The amounts you save will be lower, but it’s important to get into the act of saving regularly. Furthermore, growing your savings is a fantastic way to avoid going into debt in the future.
Remember, you should monitor your efforts often. This means that nothing is set in stone. Start with what you can and change it when you’re able.
Why You Should Pay Yourself First
Prioritization is essential when managing your money. It’s easy to get your paycheck, spend on things you want, pay your bills, and have little remaining each month.
Not only does that expose you to potential debt, but it also makes it difficult to reach long-term goals. Worse, it even makes it challenging to increase your net worth.
You are your most important need. Taking money from each paycheck to put towards your goals is the best way to accomplish them.
It’s important to view your goals as a bill that needs to be paid before everything else. Go into paying yourself first with a plan.
This will help you build wealth and spend money as you wish without fear of limited resources.
How Much Should You Pay Yourself Per Month?
Every situation is different, so it can be difficult to determine how much you need to save. However, the 50/30/20 budget is a good framework to determine how much you should save each month.
Here is how the philosophy recommends you allocate your income:
- Spend 50 percent of your budget on necessities like housing and food
- Allocate 30 percent of your budget to discretionary spending
- Spend the remaining 20 percent on savings
Let’s take the example of earning $5,000 per month after taxes. Following the 50/30/20 model, you would allocate $2,500 to needs, $1,500 to discretionary items, and $1,000 to savings.
The saving portion is a combination of all of your savings efforts. That can be anything from retirement savings to putting money in your emergency fund and everything in between.
Remember, we all have different circumstances. If you’re unable to save 20 percent of your income, save what you can. But, if you can save more than 20 percent, do that.
Use the strategy that works best for your situation to achieve optimal success.
Paying yourself first is a fantastic way to achieve financial stability. It puts your priorities first and can lead to wise money management.
You won’t get to where you want overnight, but starting now gets you one step closer to building wealth and security with your finances.
How much of your finances do you have automated?