What if, when you received your paycheck, the first thing you did was to put your money towards your biggest financial goals – that vacation savings account, the house down payment, or the new car fund? With the pay yourself first budgeting method, this is exactly what you do.
Instead of building your entire budget around your expenses, you build your budget around your savings goals. You automatically designate a certain amount from your paycheck to your savings or investment account – and then afterwards, you pay for your monthly living expenses and discretionary purchases. This method is one of the best ways you can build up your personal wealth and make your money truly work for you.
What Does it Mean to Pay Yourself First?
Paying yourself first is a way to ensure that you make your savings contributions paycheck after paycheck. As things pop up in life, it can be tempting to put those contributions towards your financial goals to the side. But a year from now, if you aren’t any closer to saving for that house down payment, how will you feel?
By paying yourself first, you ensure that some of the money always goes to your savings. This is a great strategy to build up your savings accounts.
Where Does the Money Go?
When you pay yourself first, the money can go to a variety of different places. You could contribute it to your savings account, to your retirement account, to an investment account, or stick it in a safe at home. The key is really contributing to those long-term financial goals such as saving for retirement, creating an emergency fund, or saving up for a larger financial purchase like a house down payment or a car down payment.
Advantages of Paying Yourself First
One of the biggest advantages of the pay yourself first method is that you are guaranteeing that you will save part of your paycheck. You aren’t going out and spending on whatever you want and then saving this rest. Instead, you are saving from the start and then spending what is left if you choose. This ensures that you will have an emergency fund in case anything unexpected happens.
This method of budgeting also doesn’t require you to categorize or justify every expense, like other budgeting methods do. You don’t have to take the time to maintain a detailed record of spending. You know you’ve already put money into your savings, then you need to pay your expenses, and whatever is left over you can spend at your discretion or add to your savings accounts. A great strategy to help with the pay yourself first method is to automate the process. We’ll touch on that more in a bit.
Another benefit is that those who use the pay yourself first method tend to reduce impulse purchases. When you put your money in savings first, then towards bills, whatever is leftover tends to be spent more thoughtfully. Alternatively, if you don’t put money in your savings first, you might feel as though you have more money to spend and will make more impulse purchases leaving you with less money to save.
Last, utilizing the pay yourself first method gets you in the habit of prioritizing saving your money. Developing a habit of saving your money is crucial to long-term financial success. It also ensures that you’re prepared for any money emergencies that may come along.
Disadvantages of Paying Yourself First
Really the only disadvantage of the pay yourself first method is that it doesn’t work in every situation. For example, paying yourself before you pay off a significant amount of debt can be an issue.
If you really want to utilize the pay yourself first method, but you do have a significant debt load to pay off, may want to take the money you would pay yourself and put it towards paying down your debt.
How to Start Paying Yourself First
Paying yourself first can be a weird thing to get used to. However, once you get in the habit of saving first, you will find that you are in a much better place financially.
Here are the steps you need to take to implement the reverse budget into your life:
Track and Analyze Your Spending
In order to make your reverse budget a success, you’ll want to have a solid understanding of how you currently spend money, where it goes, and what changes you are willing to make in order to reach your financial goals.
Don’t just try to guess how much you spend and on what. When people do this, they often underestimate how much they spend on discretionary purchases. Instead, take a look at your all of your purchases for the last two or three months. This will give you a much better picture of your typically spending patterns.
Identify Your Short-Term and Long-Term Financial Goals
The next step in creating a pay yourself first budget, or a reverse budget, is determining what your financial goals are. What would you like your money to be going towards? If you don’t currently have an emergency fund, how much can you do you feel comfortable putting in that?
Additionally, think about what large purchases you’d like to make in the next three to five years. If a house or new car is on that list, you better be putting money towards those goals. If you’d like to take a vacation soon, you’ll want to put money towards that as well.
Determine How Much You Need to Pay Yourself
Once you know what your goals are, it is much easier to figure out how much you need to save for them. For example, if you know you want to have the money for a house down payment of $10,000 in 5 years, then you’ll need to save $2,000 per year. If you get paid bi-weekly, you are paid 26 times in a year. That means you’ll need to save about $77 per paycheck in order to save $2,000 per year.
When you break your goals down in this way, they can seem significantly more realistic. However, if you have several different savings goals, you might need to pay yourself quite a bit in order to meet all of them. Just make sure that you also have money leftover to cover your necessary bills and living expenses.
Most financial experts recommend sticking to two or three savings goals at a time. Then, once you’ve saved a significant amount towards one goal, you can always add an additional goal.
Automate the Process
As mentioned previously, automation is a key to having success with the pay yourself first method. You can set up automatic deductions from your paycheck to send money directly to a savings account, retirement account, or investment account. By automating these payments, you are making sure that you are paying yourself first. If you have to manually transfer money every paycheck, it will be much more difficult to do because you will be tempted to spend that money elsewhere.
Monitor and Adjust As Needed
Like all budgeting methods, you probably won’t get it perfect right from the start. Once you get it set it up, you’ll need to monitor how things are going and adjust as you need. If you keep running out of money or are having lots of money left at the end of the month, then you should probably adjust how much you are paying yourself.
Strategies for Finding Money to Save
If you feel like you don’t have enough income to prioritize saving money first, these three strategies might help. And even if you already have enough income to pay yourself first, these strategies can still help.
Reduce Spending and Start Saving
Take a look at your expenses. Do you really need a subscription to all of the major streaming services? Could you cut your daily latte habit back to three days per week, instead of five? Once you make these cuts, you will be surprised how much you can actually save each month.
Get a Side Hustle
If almost all of your current income goes towards bills and debt, and there doesn’t seem to be much you can cut without being miserable, then it might be time to consider a side-gig. There are plenty of home-based part-time jobs you could consider, and you could save most (or all) of the income from this job.
While downsizing on your home or car can certainly result in savings, it may be unrealistic. That being said, almost everyone has items laying around that they no longer need. Instead of shoving it in a closet or storage unit, sell the items you no longer need. Then save the money you have left over from selling your items.
Why Paying Yourself First Works
Paying yourself first, if you can get into the habit, truly works. When people try to pay their bills first, and then they spend a little extra here and there, they often find that they don’t have anything leftover to save.
But if you pay yourself first, then pay your bills, you’ll figure out how to make ends meet with the money you have left - and reduce your spending on impulse purchases you don’t really need.
If you want to meet your financial goals faster, or you want a budgeting method that isn’t very time-consuming, consider the pay yourself first budgeting method.
By implementing the pay yourself first budget, you can start building your way to a healthy financial future. However, this method might not be for everyone. If you find that you are not able to utilize this method effectively, you might consider another budgeting method that makes more sense for the way you want to manage your money.
About the Author
Melinda Pettijohn is an expert personal financial writer with more than 10 years of experience in the industry. She covers topics ranging from budgeting, additional ways to make money, credit cards, managing debt, paying for college, and more. As a mom of three kids, she especially loves sharing insights on how to make the most of your money while raising a family.