How to Pay Yourself First

Investing Advice shutterstock_394098637

Paying yourself first is a budgeting strategy that suggests individuals should contribute to a retirement account, emergency fund, savings account, or other savings vehicle before spending their paycheck on anything else.

The pay yourself first method is a pretty simple concept to understand, but actually applying to your own finances can become a little more complex. To help our Minters put this plan into practice, we’re breaking it down step-by-step and revealing some of the advantages and drawbacks of paying yourself first.

If you already have a solid grasp on the topic, use the links below to navigate throughout the post, or read all the way through for the full picture.

What does it mean to pay yourself first?

Pay yourself first definition: The pay yourself first method, also known as reverse budgeting, is a savings strategy that says individuals should save a portion of their paycheck before spending any other money on bills, groceries, or discretionary items. The amount saved is typically predetermined as part of a larger savings goal, and is often funneled into retirement funds and/or savings accounts.

Many financial experts and individual consumers who subscribe to this method choose to have funds automatically redirected into their elected savings account(s). 

For example, if you want to put $200 of every paycheck toward your 401k, you could set up an automatic contribution rather than physically transfer funds each pay period. For many savvy savers, this makes it easier to commit to a monthly goal, because the amount never actually reaches your checking account, but is rather allocated directly toward your savings.

Note: There are several options you can employ to make the pay yourself first strategy work for your finances. If you prefer to make the transfers on your own instead of automatically, that’s totally okay! This budgeting style is really all about consistency — contributing a set amount each month to your retirement plan or savings account can really pay off over time.

Advantages of the pay yourself first method

Like any financial decision you’ll make in your lifetime, you’ll want to consider the pros and cons of subscribing to the pay yourself first philosophy.

The primary benefit of setting aside savings first, is building the amount you have saved over time. This strategy forces you to live within, or below your means — so long as you don’t start swiping your credit card recklessly instead.

Here are a few other potential benefits you could reap if you employ the pay yourself first strategy:

  • You can save up for big purchases, like a home, car, or dream vacation. Or, put your hard-earned dollars toward an emergency fund, personal savings, or retirement.
  • Contributing to accounts that earn compound interest allows your money to continue growing the longer you leave it untouched.
  • Many retirement funds and other savings options are considered “tax-advantaged.” This means that your dollars may be exempted from tax, or in the case of IRAs and 401ks, tax-deferred; so you’ll pay taxes later on when you make a withdrawal.

Drawbacks of the pay yourself first method

In addition to the positive aspects a pay yourself first budget may offer, there are some potential drawbacks that could ensue under certain circumstances. Put simply, the strategy simply does not work for everyone. As you learn about the pay yourself first method, consider how it fits into the context of your personal finances.

Here are a few examples where paying yourself first may not work to your benefit:

  • Without following careful money management advice, you may find yourself scraping for change to make ends meet. Before you commit to a monthly savings goal, use a budgeting calculator to determine how much money you can reasonably afford to save each month.
  • While prioritizing your savings can help you boost the balance in your savings account, it may be worth paying down debt first. Because interest compounds over time, waiting to pay off a credit card or a student loan, for example, means that you’ll pay more interest the longer there is an outstanding balance.

As you consider the various strategies you can use to build your savings, remember to take a close look at the potential pros and cons you may encounter. There are plenty of saving styles you can leverage, so don’t count yourself out if this one isn’t the best fit for you. For more help creating a budget and savings plan that meets your needs, check out how Mint can help!

How to Pay Yourself First

Now that you know what it means to pay yourself first, and have had a moment to consider the potential benefits and drawbacks, let’s take a look at how this strategy actually plays out, step-by-step.

1. Evaluate your monthly income + expenses 

Before you decide on the amount you want to save each month, take a look at both your fixed and variable expenses. Your fixed expenses are those costs that stay consistent month over month, like your rent or mortgage payments, student loan bill, and health insurance, for example. 

Your variable expenses, on the other hand, aren’t always the same amount each time, and sometimes you don’t incur them at all. Entertainment costs, vehicle maintenance, and groceries are all examples of variable costs, and so, their price tag may vary from one month to the next — just do your best to estimate these.

Once you can project your monthly expenses, subtract the amount from your monthly income to see what’s leftover. Depending on your savings and greater financial goals, you can tweak some of your spending to free up more cash.  

2. Identify your savings goals + commit

Now that you have a better understanding of your income and expenses, you can set some savings goals!

If you’re not sure where to start, consider the 50/30/20 rule.

The rule says…

  • 50% of your budget should go toward essential expenses such as housing, food, utilities, an minimum debt payments
  • 30% should be reserved for wants and lifestyle expenses
  • 20% should be funneled into your savings and any extra debt payments

If you don’t want to crunch the numbers on your own, try out our 50/30/20 calculator and we’ll do the heavy lifting for you!

In addition to setting forth a savings target, you’ll also want to think about where you want your reserved cash to live, and hopefully, grow. If you want to save up for retirement, a 401k or an IRA might make sense, whereas traditional savings accounts might work better for those wanting to save up funds for a shorter length of time.

3. Review + reevaluate 

Whether you’re using the pay yourself first method or another savings strategy, it’s important to remember that your budget should never be static. As life changes, your finances follow. A better salary or a reduction in your living expenses could present more opportunities to save, while a pay cut or recently incurred expense could have the opposite effect.

To keep your budget optimized and up to date, take the time to review and reevaluate it on a regular basis, and when significant changes arise. 

Wrapping Up

The pay yourself first budgeting style can be a favorable way to boost the balance in your savings account,  retirement fund, or other savings goal. However, budgeters should reflect on their unique financial situation to assess whether this strategy suits them. In most circumstances, it would be in your best interest to pay down debt before you start making monthly contributions to your savings.

If you subscribe to the pay yourself first philosophy, follow these three steps:

  1. Evaluate your monthly income + expenses 
  2. Identify your savings goals + commit
  3. Review + reevaluate

Need some extra guidance to find the right budget for your lifestyle? Mint gives you a data-driven perspective, helps you launch and track savings objectives, and empowers you to actualize your greater financial goals.

Tags:

Leave a Reply