What’s one thing that all money savvy people have learned to do? It’s something called pay yourself first.
It’s simple in theory: you make a payment to yourself before you pay any of your other bills. But it becomes a very powerful practice because it prioritizes saving money over anything else.
You’re not waiting until the end of the month to save what’s leftover. You save first, every month, always.
Pay Yourself First: What It Is, Why It Works, and How to Start
What does it mean to pay yourself first?
Paying yourself first means you are making regular contributions to your savings before taking care of your bills or other expenses. You pay yourself before buying groceries, making your car payment, going out to eat, or doing any other spending. It’s a strategy that prioritizes yourself and creates a consistent savings routine.
You can pay yourself first by setting up automatic deposits, routing a portion of your paycheck to savings, or moving money yourself. The goal is to put money in savings each month before you do anything else with your money.
Paying yourself first is sometimes known as reverse budgeting because you plan your spending around your savings goals, rather than saving whatever you have left after a month of spending. Again, you’re making saving your top priority.
The advantage of paying yourself first
A lot of people go about their regular spending and then if there’s any money left at the end of the month, that’s what they save.
But there’s a problem with that. After you’ve paid your mortgage or rent, put gas in your tank, paid your phone bill, and whatever else you spend money on, there’s usually not much left at the end of the month. How are you going to save for the vacation you’ve wanted to take, emergencies, or retirement?
Starting to pay yourself first fixes that in a few different ways…
You’re building good savings habits
Putting money in savings before you do anything else ensures that you’re saving money each month. This new routine reverses the way you’ve previously saved – you’re saving a set amount before you spend anything, and setting a monthly budget based on what you have after savings.
You’re prioritizing yourself and your financial future
A funny thing happens when you pay yourself first – you tell yourself that you and your future are more important than any of your other bills.
And while we’re all beholden to some outside financial obligations, your savings can reduce some of these commitments so that you can focus on yourself even more. This is how you create a savings buffer, build wealth, and find financial freedom.
You’re better prepared for emergencies
Saving money can prevent future debt. And too much debt, especially high-interest rate consumer debt, leads to financial stress.
Here’s an example: Say your AC goes out in the middle of the summer. If you’ve been paying yourself first, you’ll have a savings buffer so you don’t have to use a credit card to pay for the repair. If you have to put an expensive repair on your credit card, that’s another bill to pay, more interest, and more financial stress. Paying yourself first eliminates a lot of that extra stress.
Paying yourself first prepares you for even larger emergencies, like having your hours cut or losing your job. You’re less likely to take on debt or borrow from your retirement savings, which reduces future money stress.
But what if you’re in debt?
Debt has been mentioned a few times, and it’s important to address how you balance paying off your debt and savings.
High-interest rate credit card debt is expensive and needs to be addressed ASAP, but you can still start a routine of paying yourself first. Once you’ve built up a small emergency fund of about $500-$1,000 – this is to prevent you from taking on more debt – you can start deferring the majority of your money towards paying off your credit card debt.
Continue to pay yourself $10-$25/month to keep up with the habit. Once you’ve destroyed your consumer debt, move on to your car loan or student loans. The debt snowball and avalanche methods are two effective strategies for paying off debt, and you can use those while you continue making a small payment towards yourself at the beginning of the month.
The small amount of money you’re paying yourself creates the good savings habit I’ve talked about, and it also prevents future debt. It’s a win-win!
How much do you pay yourself first?
There’s not an amount that works for everyone because everyone’s situation is so different. But you can try this: think about an amount that you’d like to save each month. Even just $100 or $200 is a good start.
The annual IRA contribution limit is $6,000 for 2020, which breaks down to $500/month. That’s a great goal. But make sure you have some liquid savings before investing all of your monthly savings for retirement.
Standard financial advice says that you should save 20% of your income. That means if you make $60,000/year, you should be saving $1,000 each month. For some people, that’s a lot, but for people who want to retire early or have other big saving goals, that percentage might not be enough.
The reality is that you need to think about financial goals and go from there.
After you’ve picked an amount, create a budget around that goal. High priority bills – mortgage, utilities, groceries, etc. – come first, and then your budget for discretionary spending.
Most likely, you will need to rethink the way you spend some of your money, which is the point.
Tips for paying yourself first
Here are a few tips to make it easier to create your new savings habit.
1. Have at least one dedicated savings account
Your checking account should be for bills and another spending, not for saving money. For one, there are much better vehicles for savings, like a high-interest rate savings account or money market account. That means your money will grow at a faster rate.
Separating your savings into different accounts, like sinking funds, will help you set and fund different financial goals. You can have one for emergencies, one for vacation savings, one for money that will be invested, etc.
2. Set up direct deposit or automatic transfers
Most employers will let you direct deposit your paycheck into a bank account, and many will let you split the deposit up to four ways. Splitting the deposit makes it easier to put money in different savings accounts.
If direct deposit isn’t an option, set up automatic transfers that move a portion of your paycheck into a separate savings account.
3. Take advantage of your company’s 401(k)
If your company offers a 401(k), especially if it has a match, enroll and start paying yourself first for retirement. There are tax benefits to using a 401(k), and a company match is essentially free money.
The phrase “leaving money on the table” applies to 401(k) matches. Your employer is offering you money for retirement, so take it.
Your 401(k) contribution comes off the top of your paycheck, so it’s another great way to pay yourself first.
4. Front-load your savings
One strategy is to set a yearly savings goal and then basically try to fund that goal at the beginning of the year. Decide how much you want to save for emergencies, retirement, taxes, etc., then be super frugal during the first few months of the year to reach those goals.
The benefit is that you can relax a little more throughout the year because you know that you’ve already set aside the money you need.
If you run into any financial emergencies or need to adjust your goals, you may have to revisit your monthly savings. But you will still have a large chunk of money saved.
5. Automate your savings with an app
Savings apps like Qapital have features like automatic transfers, round-ups, and triggers that can automate your savings. The only downside is that most savings apps will cost you a few bucks each month. Check out the features, and then decide if one is the right choice for you.
Read more at Automated Savings Apps: Are They Worth It?
How to start saving more
Some of you might be reading this thinking, “Bobby, I really want to pay myself first, but I really don’t think it’s possible.” I hear you, and the hard reality is that saving money is a challenge.
Fortunately, I have a few ideas that can help you start saving money:
- Start a side hustle and put the extra money you earn directly towards savings. A side hustle is probably the most effective way to start saving more. As soon as you earn money from your side hustle, put it in savings. Whether it’s $20 you made from taking surveys or $1,000 from your Facebook ads client – all of it goes towards savings.
- Start with small amounts and slowly build from there. Starting to pay yourself small amounts of money will build your confidence and help you realize that you can save money.
- Cut your expenses and bank the difference. Here’s one example: after you switch from cable to a less expensive streaming service, make a payment to yourself for the amount you're saving each month. In addition to cutting cable, there are lots of easy ways to reduce your monthly expenses.
- Use the 30-day rule. The 30-day rule is a way to prevent impulse spending. The basic idea is that you wait 30 days between wanting to buy something extra and actually making the purchase.
- Try a savings challenge. Challenges like the 52-week money challenge make saving money like a game, which is a good motivator for some people.
The final word on paying yourself first
Just like any other new routine, it will take some time to get used to paying yourself first, but most people are surprised by how easy it is.
You might feel a little sting the first month or two as you adjust to your new budget, but skimming money off the top eventually makes you forget you had that money to begin with. And trust me, your future self will thank you.
About Millennial Money Man
Bobby Hoyt is a former band director who paid off $40,000 of student loan debt in 18 months on his teaching salary and then left his job to run Millennial Money Man full-time. He helps other Millennials earn more through side hustles, save more through budgeting tools and apps, and pay off debt. He is a personal finance expert who has been seen on Forbes, Reuters, MarketWatch, CNBC, International Business Times, Business Insider, US News, Yahoo Finance, and many other personal finance and entrepreneurship media outlets.
