Pay yourself last is okay too

by Philip Brewer on 26 January 2008 11 comments
Photo: Philip Brewer

Every book on personal finance says that you should pay yourself first--get the money out of your checking account and you won't even know it's missing. There's a lot of truth to that, but the pay-yourself-first model has some downsides, as well. I found that paying myself last actually worked better.

Just to be clear, I actually did both: my 401(k) money came out before I got my paycheck, and that money made up the bulk of my savings when I was working a regular job.

In addition to that money, though, I was also saving some after-tax money, with an eye toward retiring before I was old enough to take money out of a tax-sheltered account. Over the years I tried various ways of getting that money into savings, but nothing worked as well for me as just waiting until the bills were paid, and then transferring what was left into my ING Direct account.

Regular savings

I tried putting a specific amount into savings each paycheck, and I tried putting a specific amount into savings each month. Both of those plans fell short, simply because of variations in the amount of money I spent each month. What with car insurance, renter's insurance, tax payments, my annual fitness center membership, car maintenance, shoes, coats, clothes, vet bills, and vacations, we simply didn't have very many months in the year when our expenses were average.

Unless the regular savings deposits were so small that money accumulated in the checking account (which is just what pay-yourself-first is supposed to avoid), we ended up having to raid our savings account to pay ordinary bills like the car insurance--and taking money out of savings as often as we were putting it in seemed to defeat the purpose.

I tried having two savings accounts--one where we put aside money specifically for expenses like insurance and vacations, and another where we put our long-term savings, but that was a whole additional layer of complexity that didn't seem to add much value.

Irregular savings

In the end, what worked best for us was just what the personal finance orthodoxy says is bad: we paid ourselves last. Each month, after we paid the bills, we looked ahead to see what expenses were coming up (we knew what we'd charged on our credit cards, and we knew which of the annual bills were coming) and we figured out how much money we needed to keep in the account to pay the foreseeable bills. Then, we transferred the rest to savings.

ARTICLE CONTINUES BELOW

I think this worked for us because we got a lot of satisfaction out of putting the money aside. For us, it was literally more fun to save the money than it would have been to spend it.

We were pretty aggressive in saving money--aggressive enough that occasionally we had to take money back out of savings to pay a bill that came earlier than expected or turned out to be larger than expected. But that didn't happen so often that taking money out of savings turned into a regular thing.

One downside: irregular investing

Even though having the money in our checking account didn't result in us just spending the money, there was a downside to paying ourselves last--we ended up saving plenty, but not getting it invested as regularly as we should have.

Our 401(k) money got invested every two weeks, letting the dollar-cost-averaging thing work to our advantage. There's no reason that we couldn't have gotten our after-tax savings invested as well (and when I had a clear idea of how I wanted to invest it, I did), but for long stretches, especially when the market seemed a little high, I ended up just leaving our savings in cash. We'd have been ahead of where we are now, if I'd done a better job of getting that money invested regularly.

First, last, or middle: pay yourself

Unless you're like us--unless you get a big jolt of satisfaction out of doing that transfer to savings--you'll probably come out ahead by paying yourself first, just like the personal finance books say to do. But don't hesitate to give pay-yourself-last a try, if it seems like it might work better for you.

The only wrong way to put money in savings is not doing it.

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Guest's picture
Julia

I too do a combo of the pay yourself first and last as well for my savings. My emergency fund comes out automatically with each paycheque deposit, and then after paying everything with each pay, I see what's left, and then deposit all or part of it into my Fun Money savings funds. The Fun Money grows more slowly than the Emergency fund, but that's okay, because it's supposed to be used for low priority items like a new tv (because I want one, not because I need one), my next vacation to Europe (I've got two years to save for that one), and the orthodontic work I've got to have done, again (sigh, don't ask).

So as Phillip says, whatever works for you is the way to go.

Guest's picture
Dwight

My income end expenses vary widely from month to month and year to year because I'm self employed. Philip's method seems to be the only reasonable thing for someone like me to do.

I think most people would benefit from this. Disconnect your spending from you income. Obviously, you need to spend less than you earn. Other than that one rule, your income should not determine your spending. Spend on the things that bring you fulfillment and save the rest of your money.

That's the approach taken in the book, "Your Money or Your Life"

Guest's picture

We do something similar, scheduling savings contributions to retirement funds/sinking funds early in the month, and the sweep any additional savings from our checking account that we've managed to accumulate at the end of the month.

Guest's picture
MK

There is a third option: a combination of the two. Every time I get paid, I have an automatic transfer mainly into my stock market account and automatic investment in mutual funds set up there. This makes up the bulk of my long-term savings. Then, around the time when I get paid the next time, unless there is a large bill coming up I literally empty the transaction account and dump all of the money that is still left into the savings account, which acts both to collect money for larger investments as well as a short-term buffer.

This works well for me: the bulk of my investing is on autopilot, so the purchase cost averages out, and if I spend less than anticipated I also get to see how the amount in my savings account grows more than it otherwise would have.

Guest's picture
Aimee

It's a good point, save how ever you can save. I think paying yourself first can work well if you are making enough to cover the bills after your savings, but for a lot of us that just doesn't work out each month. At least saving something is better than saving nothing!

Philip Brewer's picture

If you only put enough into savings each month so that, even in the months when you have a big insurance or tax bill, you still have enough left after savings to pay all your bills, then you're not saving as much as you could in the other months.

That's what eventually pushed me into sending money off to savings after the bills were paid--that's when I knew how much was available for saving.

Guest's picture
Toby

"car insurance, renter's insurance, tax payments, my annual fitness center membership, car maintenance, shoes, coats, clothes, vet bills, and vacations"

When you are attempting to deal with irregular but expected bills, I find starting a freedom fund to be most helpful. There is no reason to be caught in the lurch dealing with an annual bill that you knew was coming.

It basically works like this. You take your bills that are not monthly and add them up. You should be able to estimate what your annual car insurance, renter's insurance, fitness center membership, life insurance, etc. costs are.

Now divide that by 12. That is the monthly deposit required to fund your freedom fund. It takes a few months to get this going but it is well worth the effort as you no longer have to plan having enough cash for some huge bill that creeps up once a year. The nice thing is that it is a rolling fund. Money comes in at a regular pace every month and it goes out when the bills arrive. The goal is not to save up the 12 month number, the goal is to just put in the monthly amount and the account takes care of itself.

Anything you can estimate an annual cost for can be added to the freedom fund. Car maintenance, vet bills, clothes budget, etc. I include car maintenance in mine but not my clothes budget.

And please note, this is *NOT* an emergency fund (although you could raid it if your situation is dire). It is not meant to handle unexpected costs, only things you expect to spend in a given year. So if you have auto maintenance included, you can pay for your oil change with it, but you should probably use your separate E-Fund to pay for the new transmission (because who saw that coming?!).

By leveling your irregular bills to a set monthly charge, you simplify things because you don't need to worry about where the money will come from to pay the real estate taxes next month. The money will be there. And with more regular expenses, you can budget around them more easily.

Guest's picture

No, no, no. Pay yourself last does not work. When you put yourself at the bottom of the list, you are putting everyone else ahead of you. That means the government gets money, the banks get money, the creditors get money... EVERYONE ELSE is getting money, and you're just taking whatever's left.

You obviously don't understand the phrase "pay yourself first", because you're misusing it here to justify bad advice. Paying yourself first means *incorporating*. It means using your money to create assets BEFORE the government, the bank, and the bill collectors get their share.

And the beauty of it is that paying yourself first gives you more money to work with. Every month your share gets bigger and everyone else's gets smaller. When you pay yourself first, you win. When you pay yourself last, you lose.

I've only been reading WiseBread for a week now, and I've already seen two pieces of really bad advice. So far, I'm not impressed.

Philip Brewer's picture

If you pay yourself first, how do you know that you're saving the largest amount possible? If you budget carefully, you may have a pretty good estimate of how much you can save, but it's still just an estimate.

If you pay yourself last, you can save everything you didn't spend.

This strategy probably won't work well for people who badly want more stuff. However, it worked very well for me.

If you pay yourself first, then when the opportunity comes to buy something you don't need, you don't have the money--it's already been saved. That's great. But what if it's some little thing, and you do have the money? It would be very easy to say, "Well, I paid myself first and I have a little money left over and I want that thing."

I find it better to wait. When the opportunity to buy some thing (small or large) comes, I have the money to buy it--but I choose not to make the purchase so that I have the money to save. Frankly, I find saving the money to be more fun than buying the thing is, for a very wide range of things I might buy.

If you're not like me, this may not work for you. But I think my point is valid. It doesn't matter whether you pay yourself first or last, as long as you do pay yourself.

Guest's picture

But you still missed the point: The phrase "pay yourself first" doesn't refer to what order you place yourself on the budget... it specifically means to take money out and allocate it to yourself *EVEN BEFORE PAYING TAXES*. It means 401k, or corporate earning.

Try funding a retirement account by paying yourself last. Go ahead. Meanwhile, I'll match you by funding my retirement account, pre-tax, with the same amount. Assuming we're invested in the same stocks or funds, we'll end with the same amount... only I'll have a much better quality of life while getting there. And that means that if I'm standing in line and want to buy a candy bar, I don't have to beat myself up over the impulse to buy it.

Guest's picture
warren currier

grabbing a chunk of the one's earnings BEFORE they are taxed may be a part of the "pay yourself first" concept in your mind. To me -- that's a piece of it all.

A very simple example of the way that I see it:

To get beyond being a wage earner one needs to build up some capital. For example, if you had a million dollars in cash sitting in an account HOW would you change your thinking about earning money? Would you?

Some guy or gal may say "I'm rich!!" and quit their job and start spending the nest egg.

Another person may decide to play it real cool and go to work and tell no one about the cool million.

That person will likely also smile more and start to think about how in the world to get this money working for her /him.

So, the idea is simple.

Ask this: "How can I build a nest egg ASAP??!!"

Okay, so you are making $1000.00 per week and you want to get independent as fast as you can.

You devise a way to live on $2,000.00 per month, or less.

Based on that reality-- you take $2200.00 every month and send it off to a bank account in a city that far enough away that you will not easily go there to get that money.

after that you simple find a way to survive every month on the money that is left over.

After two years you have >$50,000.00 savings.

You started from zero and your job only paid one-thousand per week.

Now you buy a property or something that will ride out inflation and MAY also give you a bit of an additional gain over the years.

Later you buy another property and rent it out.

By paying yourself first you forced this savings upon yourself in order to change your life from a mere wage earner to something else... (perhaps are wage earner that is also a landlord).

By saving one-half of earning each month you have "paid now" so that you can break free by growing some assets. Perhaps you will be able to "play later".

What we are not being taught is not complicated.

Either you can "play now" and "pay later"... or...
with proper guidance and a certain amount of discipline one can learn how to "pay now" in order that s/he may come to be able to "play later".

Building wealth, building real wealth, can be fun to do AND it makes you realize that it is all up to you.

No government or social program, or POTUS or president of any where else needs to be your savior.

No free cellphones.
No Social Security in the future.
No welfare safety net in xx years in the future.

No problem!!
You saved yourself through good habits and a plan.