Pay Yourself First: What It Means, and How to Do It

by Debbie Dragon on 28 March 2012 6 comments
Photo: 401K

If you have ever read a retirement planning brochure or any website about investing, there’s a good chance you have read the phrase “pay yourself first.” Some financial experts refer to this as the Golden Rule of Personal Finance! But what does it mean to pay yourself first, and how exactly do you do it? (See also: A Comprehensive Guide to the Debt Snowball Method)

Pay Yourself First: What Does It Mean?

This commonly used phrase refers to the practice of automatically making a savings contribution or investment with your income before it can reach your wallet. You “pay yourself first” when you contribute a percentage of your income to your retirement plan or savings account each pay period. The transfer to your savings or investment account is done automatically, before you receive the rest of your income for paying your monthly living expenses. When you pay yourself first, you ensure the specified amount of money you want to save really does make it into your savings account or investment, since it happens before you have the opportunity to use the money for something else.

If you don’t pay yourself first, you will probably find yourself at the end of each pay period or month without any money left over to save or invest. If you plan to save what you have after you pay your rent, groceries, loan payments, credit cards, and entertainment costs, there is a very good chance that there will be no money left after your expenses and discretionary spending. Making the decision to pay yourself first removes the temptation to skip a planned contribution and keeps your savings and investment goals on track.

Creating a system for paying yourself first establishes a priority for your savings and helps you develop strong financial habits. People who spend their money in the reverse order — paying everything else before saving — generally reach their retirement years without a nest egg.

Setting Up Automatic Savings Plans

The easiest way to make sure you save a percentage of your income each and every pay period is to pay yourself first with an automatic savings or investment plan. Consider your savings or investment another expense that you must pay, and set it up just as you would any other automatic payment made to one of your creditors. Then you can forget about it. The money is invisible to you, and you will learn to adjust the rest of your spending habits to the income you have after your savings or investments are made.

If you receive a paycheck from an employer, you can usually designate a certain percentage of each pay period to your employer’s 401(k) plan or to a savings account. Some employers will allow you to have more than one direct deposit created, which means you could contribute a specific dollar amount or percentage of each paycheck into your 401(k) plan, and a specific dollar amount or percentage of each paycheck into your savings account.

If you are self-employed or receive income sporadically, you can still take advantage of the “pay yourself first” strategy. Each and every time you receive income, deposit a specific percentage in a designated savings or investment account before you use the money for anything else. This requires more financial discipline than having your employer deposit the money before you get paid, but if you make it a habit, you can still pay yourself first and benefit.

Additional Tips for Paying Yourself First

The biggest challenge of paying yourself first seems to be the mentality of not making enough to save and finding it hard to get started. If you feel like you aren’t making enough money to save, try starting with a very small amount, such as 1% of your income. From every paycheck or income received, simply save 1% of the amount, each and every time. You will not miss this amount, and over time, you will have saved some money.

When you pay off existing debts and find yourself with more discretionary income each month, or when your income increases due to a pay raise or promotion, you should increase your savings percentage.

4.333335
Average: 4.3 (3 votes)
Your rating: None
ShareThis

comments

6 discussions

Add New Comment

CAPTCHA
This test helps prevent automated spam submissions.
Meg Favreau's picture

Another way for freelancers to pay themselves first is to, if you have a certain regular client or gig, always put that check into savings.

Readers, do you have any other approaches to paying yourself first?

Guest's picture

Great post, and everyone should be doing this one. One should definitely consider the benifits of making sure their bank (for savings accounts) give them the best rates. I was amazed at how much more I could pay myself first by switching to ING Direct from my traditional brick and mortar location.

Guest's picture

I use an automated transfer funds monthly to my TD Ameritrade brokerage- I use them because they have no commission costs on a range of low fee ETFs. I use asset allocation to decide where to invest the money- automatically doing a bit of rebalancing each month.

Guest's picture

Basically, it's setting aside money first before doing anything else like pay bills, buy groceries. Before I have always thought that I should pay all the bills first, then buy the groceries then put away some cash from the money I got left over. But now that I think about it, it's better to stow away some cash first so that you can learn to budget with what is left behind. Spending is higher if one has more to spend, likewise it decreases if there isn't that much to spend.

Guest's picture
Preeti

Setting up an automatic savings plan is probably the best way to pay yourself...it helps you build long term wealth and in most cases helps you save enough that you can live well on your retirement.

Guest's picture

Please...Please...Please... teach your children this critical principle. Isn't it interesting to see how people change so much from when they were kids? Not saying this is the only scenario but definitely one I've seen time after time...

Most kids usually pay EVERYTHING to themselves first. Understandable - they have no other obligations. The challenge seems to start when they get those other obligations and they're not trained to handle them.

So many kids get a cell phone, a car, a credit card and "forget" to pay those bills and get in trouble. After a time doing this they get messed up financially and then have to both catch up and continue to pay the bills. In the meantime, spending continues and even (gasp) increases! Eventually, things are reversed and paying themselves first, comes last, if at all.

Is that how many people reach the same problem and now need to "re-gear" their financial thinking? How much better it would be to be taught this (and other) financial principles when young and mentored to watch out for the financial dead ends.