It’s all too common for people to get their paycheck and immediately start paying bills and buying up their “wants” before setting any money aside for savings or investment contributions.
The idea behind the Pay Yourself First rule is that you should set aside a percentage of every paycheck to go into your savings account or contribute to your IRA, 401K, index fund, or any retirement portfolio.
Ideally, you can do this by having your HR department automatically deposit a percentage of your check into one of these accounts or setting up an automatic transfer or debit through your financial institution.
Paying yourself first does not mean giving yourself $100 bucks from each paycheck to buy new shoes or a new Xbox game. That’s not paying yourself. That’s just buying up your “wants.”
The Idea Behind Paying Yourself First
57% of Americans have less than $1,000 in savings. About ¼ of Americans either have nothing in savings and/or their bank accounts are negative. Paying yourself first is a simple tactic that even the best financial planners and investment advisors will suggest everyone follows. Even if you’ve got a million bucks saved up, they’re still going to suggest the pay yourself first guide, albeit at a much lower rate.
The underlying principle behind paying yourself first is when funds are automatically transferred to the savings or investment account. The temptation to spend the money rather than save it has been removed.
Why You Should Pay Yourself First
Financial planners and accountants’ primary reason tout paying yourself first as a top priority is because regular contributions to a savings account, retirement account, or investment account go a long way.
Whether you’re creating an emergency fund, saving up for retirement, or have a big financial purchase coming up in the future, removing the temptation to spend before saving or spend before contributing is the only method that works for most people.
How To Properly Pay Yourself First
“So I just need to tell HR to put 10% of my paycheck into my savings account, and I’m good, right?” — Well, not exactly. While 10% is better than not saving at all, and while it may be a good amount for some people, paying yourself first is not as simple as us telling you, “Just save x%, and you’re good!”
Step 1: How are you currently spending your money?
If you don’t sit down to fully assess your spending, you won’t know how much to pay yourself to get the full benefits. You can sit down and log into your online banking or credit card statements, or you can use one of the free services like the Mint App or the Personal Capital App.
This is a great way to get an idea of how much of your money goes to groceries each month or how much all of your utilities total up to be throughout the month. If possible, round up and be conservative in the beginning.
Step 2: Figure out how much you should pay yourself.
Just about any certified financial planner or any big-name financial planning website will talk highly of the 50/30/20 rule for beginners. This can vary depending on one’s income or current monthly obligations. Ideally, your income should be broken up in the following fashion:
- 50% covers necessities each month
- 30% covers your “wants” and entertainment
- 20% goes to savings and paying off debt
Step 3: Identifying your short-term and long-term savings goals.
Sit down and take a long, hard look at what your goals are for saving. Ideally, an emergency fund and retirement account should be top priorities, whereas something like a vacation or a new car shouldn’t be high up on your list.
If, for example, you need to create an emergency fund, want to go on vacation, and haven’t started a retirement account yet, then you now know what your goals are. To keep in mind, if you’re saving for the vacation, that should come out of the 30% “wants” chunk of your paycheck that we listed in the 50/30/20 rule above.
When you pay yourself first, you sit down and take in the big picture of how all of your hard-earned money is being spent. Additionally, you can consider what your short-term and long-term goals are. It’s a great way to focus on that big picture you painted earlier and stop making impulsive purchases. It’s also one of the best possible ways to learn the art of delayed gratification.
Paying yourself first is great for those new to saving and who want to control their personal finance.