Personal finance can seem like such an amazingly complex topic at times. There are so many things to think about with financial management including budgeting, saving, investing, credit, debt, mortgages and so much more. Each topic has sub-topics – and it feels like it could take a lifetime to figure it all out. It can be overwhelming.
A few days ago I talked about how we as humans like to take things that are basically simple, and make them more complex. In that article I argued that we should “keep it simple stupid” and try to focus more on some of the basics, instead of trying to make things too complex.
In the spirit of going back to the basics, today I want to start a series of posts called “Personal Finance Basics” where I'll be talking about some of the simple concepts of personal finance that I believe you should focus on in order to be successful. Today, I'll be talking about saving and paying yourself first.
Pay Yourself First
One important piece of advice that you often see repeated, but not followed is the simple advice of paying yourself first. This advice has been around for ages, so sometimes it seems a little antiquated – something your grandfather might tell you. The thing is, it works.
JD from getrichslowly.org explains paying yourself first this way:
Before you pay your bills, before you buy groceries, before you do anything else, set aside a portion of your income to save. The first bill you pay each month should be to yourself. This habit, developed early, can help a person build tremendous wealth. I wish I’d understood this when I graduated from college.
So to pay yourself first you make your saving a priority – and as soon as your paycheck comes in, you pay yourself, and fully fund your savings and investment goals.
The problem is that most people don't pay themselves first. They play the game backwards – and end up following a system where they pay all their bills, spend on entertainment and eating out and the last thing they do is fund their savings and investment goals. When they do that they often end up running out of money before they are able to fund their savings. Savings becomes a footnote and gets lost in the shuffle.
Why Should I Pay Myself First?
While most people agree that having some sort of savings and investment plans is important, not everyone agrees about how to get there. For many it just seems too hard to save their money first because they feel like they've got too many other spending and debt priorities.
Here are some of the reasons why I believe that it's important to pay yourself first.
- Paying yourself first makes saving a priority: When you save last by default it means that all of your other bills, spending and other monetary obligations are more important that saving for your future. By paying yourself first it makes your saving and investment goals the priority.
- Paying yourself first equals sound financial planning: When you pay yourself first it means that you're planning ahead – not just for the far future – 30 years down the line – but also for every day emergencies like medical issues, car troubles and so on. When you save first and have an emergency fund, you'll be ready when these problems crop up.
- Paying yourself first can help motivate you to reach your goals: When you pay yourself first you'll see your savings and retirement accounts growing faster than if your savings goals came after your bills and entertainment expenses. Watching those savings can be very motivating to help move you towards reaching other goals as well!
How Should I Pay Myself Automatically?
Once you decide it's a good idea to pay yourself first, the next step to take is to put a plan in action in order to actually pay yourself first. For me the best thing you can do is make paying yourself first automatic.
Here are some ways that you can work towards reaching your savings and investment goals.
- Set up automatic investments: Set it up with your company to automatically invest in your company's retirement savings plan, especially if they have a plan that matches your investments. If they do it's an automatic 100% return right away! If they don't match think about setting up a tax-free Roth IRA and maxing that out first. Then open one of the variety of pre-tax investments and maxing those out. If you have the money come out of your paycheck before you even see it, it makes it much easier to make a plan that doesn't include that money!
- Open a high yield savings account: Open up a online savings account where you can set up an automatic savings goal – where money is withdrawn for your savings every month without you having to do anything. Again, making it automatic makes it much easier!
- Come up with your own ways to trick yourself into saving: Doing things like saving coins and adding them to your savings, or saving every $10 bill that comes your way are examples of ways you can increase and add extra savings.
What are some ways that you can come up with to trick yourself into saving? Do you have thoughts on why it's important to pay yourself first? Tell us your thoughts in the comments.
I find this statement interesting:
“Before you pay your bills, before you buy groceries, before you do anything else, set aside a portion of your income to save.”
What if you do not have enough to cover your current bills or buy food for the family?
Not having enough to cover the basics has to be a temporary situation. You would need to earn more or reduce expenses. But in that case should you still pay yourself first?
Mr. Money says
Well if you’re not making enough to cover your expenses and still save, you’ve got a crisis of income – and no – you probably shouldn’t be saving first. First you should make it a priority to find ways to better yourself, increase your available income, and get to a place where you can afford to save first.
Maruti Nandan Pandya says
I would say it is a two-way problem. If you are not making enough to cover your expenses, you certainly need to find ways to increase your available income.
But I have also found many youngsters that are not able to cover their expenses not because they do not earn more, but because most of their expenses are actually luxuries or payments for instant gratification.
As a second task, one should also see at their monthly budgets and make sure they are not overspending in the first place. I do not ask to live frugally but to have priorities over luxuries.