Have you ever heard someone say you should pay yourself first?
It’s a new idea for personal finance followers and is very important for people who don’t have extra money at the end of the month!
Paying yourself first is a term that’s been around for many years and has also been called the “Reverse Budgeting Method.”
Paying yourself first can be beneficial to save more money in various ways or set money aside for what you enjoy. When you pay yourself first, you take advantage of the automatic savings and investing process.
Let’s take a look at five steps to first pay yourself, make the most of your money, and better prepare for future financial independence.
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What Does It Mean to Pay Yourself First?
Paying yourself first means taking your earnings and immediately paying yourself before doing anything else.
This can be done in several ways, but the most popular is to have the money transferred directly from your paycheck to designated financial accounts.
So, even if you have debt repayment or expenses, you still go ahead and contribute to savings accounts and retirement account first.
Benefits Of The Pay Yourself First Method
There are several benefits of using the Pay Yourself First Method of personal finance.
1) It creates a budget for you. When you pay yourself first, you make a budget to manage your money and give yourself more cash for other things besides bills.
2) It helps you get used to living frugally. Like any other budgeting method, you have to be conscious of how much money you are spending.
3) You’ll start to want to save more! When you get into the habit of saving and investing money, you’ll likely want to keep it up and be willing to save or invest more.
5 Steps To Pay Yourself First In Budgeting
1. Create Your Reverse Budget
The whole idea of this method is based on paying your savings first and then using the rest of your money for bills and living expenses. This is opposed to the traditional budgeting method of planning your budget around living expenses and then saving what is left over.
Identify Spending Habits
One of the most important financial steps in setting up a successful reverse budgeting plan is identifying your spending habits.
It allows you to identify areas where you might be overspending, which keeps you from saving or paying off debt.
First, list all of your monthly expenses. Use a budgeting app like Mint and Personal Capital to help you identify your spending habits.
Figure Out Your Savings Goals
Start your financial plan by setting long-term savings goals for retiring early or at 65 (only 1/4 people do!), set up an IRA or 401(k), and increase what you put into it over time.
And don’t forget to set short-term financial goals as well! Maybe you want to pay off your credit cards, so you’re debt-free sooner- add some extra cash onto your payments, and increase it when you can.
2. Decide What Percentage You’ll Pay Yourself First
There are a few financial strategies people use to divvy up their income- you can try these below and see which one is the most feasible for you- or try any other combo you think works!
- The 50/30/20 rule: 50% for spending, 30% for savings, and 20% for other expenses (like taxes)
- The 1/4 rule: save 25% of your income while living on the other 75%
- Some prefer to put 10-15% towards savings while living on 85-90% of their income
3. Save Automatically
Setting up automatic transfers of a specified percentage of your income from your checking account into a savings account or investment account helps you stay on track when it comes to achieving financial goals.
You can see if your bank has an automatic savings feature, meaning you can set up how much of your income can get deposited directly into savings. It also isn’t too hard to do it yourself in your banking app!
4. Invest For Your Future
The more cash you use wisely now, the more you’ll have down the road. Investing is a way to start saving in a different way, earning more on your cash than you would in only a checking account.
1) Invest your money
If you want money down the road, investing is how you start. try putting your funds into retirement savings accounts such as 401ks or Roth IRAs. It can make a big difference later on in life when it comes time to retire and live comfortably.
You can also start investing your cash now through a robo-advisor like M1 Finance or Betterment to automate your investments easily, or you can do more hands-on investing with Robinhood, which is great for beginners and gives you free stock!
2) Create an Emergency Fund
It is essential to have savings set aside in case of emergencies. That way, you aren’t stuck with massive debt because of one unfortunate event.
3) Buy Insurance
You’re going to need things such as life insurance and long-term disability care, which costs money now to save money later. Insurance could be a great way to protect your family from financial trouble if you can’t work or pass away.
5. Pay Off Debts
Lastly, you need to pay off your debts. This way, you not only free up more cash to save each month, but you also decrease the amount of interest you pay.
It may seem odd, especially if you’re struggling with debts now. It’s usually one of the first steps in other budgets, but paying yourself first puts focus on money toward your wants and future needs and then focusing on the current bills.
Once your debts are paid in full, start putting your old payment amount towards savings instead! This will help you get ahead financially and allow you to reach your long-term savings goals quicker.
Tips For Reverse-Budget Steps
Be Thorough & Realistic
Make sure you are realistic about what you can and cannot afford and be thorough, including all of your regular and occasional expenses.
It’s best to create a plan that you can stick with for at least six months, so you know whether or not it is working. This will allow you to view your success and make any necessary adjustments.
Review Often & Reevaluate As Needed
Your budget and the pay yourself first plan will likely need to be tweaked as time goes on. That’s okay! The important thing is that you regularly review your financial progress and make changes where necessary.
If the idea of saving a large percentage of your paycheck seems daunting, start small. Save 5-10% until it becomes more comfortable, then increase the amount to improve your situation further.
Find Ways To Save Money Routinely
There are many ways to save money each month that can add up over time.
Some examples include bringing your lunch to work, using your card to avoid more debt, canceling unused memberships, and turning off electronics when they’re not in use.
You can also sign up for apps like Honey or Ibotta to get coupons, cashback, and more to reduce your bills and save more money!
Pay Yourself First- Example
Let’s run through an example of reverse budgeting for a receptionist named Sally, who lives in Nashville, TN. She is unmarried and makes $5,000 each month after taxes.
Identify spending habits
First, Sally will make a list of her expenses to get an idea of her spending habits. She has listed her monthly fixed expenses as $2,650 for a two-bedroom apartment near downtown Nashville, $200 for utilities, $400 for car payments and insurance, and spending around $300 a month on groceries.
Decide what percentage to save
Next, she decides to save 20% of her income for long-term savings goals. Breaking it down further, she wants to put 15% to her retirement fund, 5% to her emergency savings account, and 5% to her housing savings account.
Pay off debts
Sally has 2 credit cards and a loan she is paying off. She pays around $300 a month in payments between the three debts.
Sally’s Initial Budget
So here’s a quick look at how her new reverse budget looks:
- Long-term savings: Retirement ($750), Emergency Fund ($250), Housing Savings ($250) = $1,250
- Fixed: Rent ($2,650), Utilities ($200), Car Payment/Gas/Insurance ($400) = $3,250
- Variable: Groceries ($300), Credit card payment ($150), Student Loan payment ($150) = $600
- Total = $5,100 each month
Review Often & Reevaluate As Needed
Sally has reviewed her monthly budget and knows she has gone over her earnings by $100. This isn’t much over, but we don’t want to overspend!
There are a few things to cut back on her expenses to give herself more wiggle room. If she doesn’t want to adjust her savings plan, she needs to review the rest of her planning for a new strategy to save elsewhere.
One possibility would be to look for an apartment with lower rent of around $1,800, as long as she is willing to downsize now to have more money later. Plus, she can look for ways to save on groceries and food each month.
Her adjusted budget will look like this:
- Long-term savings: Retirement ($750), Emergency Fund ($250), Housing Savings ($250) = $1,250
- Fixed: Rent ($1,800), Utilities ($200), Car Payment/Gas/Insurance ($400) = $2,400
- Variable: Groceries ($200), Credit card payment($300), Student Loan payment ($300) = $800
- Total =$4,450 each month
Now she has paid herself first and taken care of the bills! And she has $550 leftover she can put towards her savings (pay yourself first!) or her credit card debt, whichever she feels like doing.
Final Thoughts
If you want to save and set aside money for your future, paying yourself first may be your priority in budgeting. Whether through retirement planning, rainy day funds, or paying off debt, these are essential to saving up for your future.
Some people fear that they won’t have enough money to cover their bills with this method, but that’s why you have to make the budget and be flexible. Your financial journey is bound to fluctuate with personal changes- you need to hunker down and get your strategy started and changed now and again!
