What is the ‘pay yourself first’ budget method?
The phrase ‘pay yourself first’ has become increasingly popular in personal finance and investing circles. While there is a huge range of budget methods that can suit every individual’s needs, the pay yourself first strategy has become an intriguing way to rethink how you approach your budget every month.
‘Pay yourself first’ is an investor mentality and phrase popular in personal finance and retirement-planning literature that means automatically routing a specified savings contribution from each paycheck at the time it is received.
The strategy basically boils down to the following; instead of paying all your bills and expenses first and then saving whatever is left over, it’s doing the opposite. On your pay day, set aside a pre-determined amount of money for investing, retirement, a down payment, or any finance goal requiring a long-term effort, and then take care of everything else.
Because the payments are automatically routed from each paycheck to your savings or investment account, you’re paying yourself before you begin paying off your monthly living expenses and making discretionary purchases.
It’s ultimately a personal finance strategy of increased, consistent savings and investment while also promoting a frugal approach to your remaining spending for the month. The goal is to make sure that enough income is first saved or invested before expenses or other purchases are made. No matter your outgoing spending for the month, your investment amount will remain the same and increase steadily over time.
Working out the basics
A lot of finance professionals and retirement planners can recommend the ‘pay yourself first’ tactic as an effective way to make sure you’re making your chosen savings contributions month after month. This budget plan relies on the fact that it removes the temptation to skip a contribution, and spend the funds on discretionary expenses rather than savings. Regular savings contributions can go a long way toward building a long-term nest egg, and increasing compound interest over time ensures your invested money is working for you.
You can outline the pay yourself first savings plan using the steps below:
- Work out your monthly income. Before paying yourself first, you need to figure out how much to pay yourself. Determining this begins with taking a look at your current monthly income – if you have an existing monthly budget this can be a good starting point for figuring out how much your mandatory expenses amount to, and how much you can afford to set aside.
- Choose how much to pay yourself. Now that you know how much you have left over each month, you can decide how much to pay yourself. Experts can recommend differing amounts, but a good starting place might be paying yourself 5-10% of your net or take-home income each month. You can always opt to increase or decrease this amount if your income of circumstances change, but keeping a consistent savings benchmark each month allows you to calculate the long-term returns more effectively.
- Set a pre-determined savings goal. Once you know how much you can pay yourself, try to set a goal for a savings amount. Are you looking towards planning for retirement? A house down-payment? Moving to live overseas in a few years’ time? Determine the cost of your goal, and divide that by the amount you can pay yourself monthly to determine how long it will take to reach your goal in months.
- Create a savings or investing account separately from all your other accounts. This account should be only set up for your specified goal. If you’re saving this amount, opt for an account with a higher interest rate — usually these types of accounts limit how often you can withdraw money, which is a good thing because you’re not going to be pulling money out of it, anyway. If you’re investing, once the funds have been successfully deposited into your investing account, you can then contribute that amount towards more shares or ETFs.
- Put that money into the account as soon as it is available. If you have direct deposit enabled, you can have a portion of each paycheck automatically deposited into this separate account. You can also set up an automatic monthly or weekly transfer from your main, active account to your separate savings or investment account.
If you decide to go with the ‘pay yourself first’ method of personal finance, you can choose to put your money in a variety of investment platforms, depending on your financial objectives. How you decide to set this money aside is up to you!
At its core, ‘paying yourself first’ simply involves building up a long-term nest egg towards your life goals – whether this means a retirement account, creating an emergency fund, or saving for other long-term goals such as buying a house.
This article is not intended as legal, financial or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered Australian legal practitioner or financial or investment advisor.