Pay Yourself First – How to Pay Yourself First – become the first and most important bill of all bills to sucessfully save money.
Paying myself first is the only savings strategy that has ever worked for me.
It’s how I am able to grow my dividend income updates each month.
It’s also a well known concept in the personal finance community.
But paying yourself first is still not utilized enough, even though it’s such an essential concept it should be taught in school.
To tell you the truth, I’m not that great with money naturally. I like to spend money. The only way I save money is by consistently paying myself first.
What does Pay Yourself First mean?
“Pay yourself first” is a savings strategy. It’s an easy way to save money.
The term “pay yourself first” refers to setting aside a portion of money earned from an income source before paying any other bills or before spending any money.
Before paying your rent, mortgage, cell phone bill, credit card, credit line, student loan, or car insurance, you save a portion of the money you earn.
Prior to buying groceries, new clothes, new books, decorations, food out, or ordering anything from Amazon, money is set aside from what you earn.
In essence, you become the first and most important bill on your list of bills.
Why Pay Yourself First?
The reason to pay yourself first is to have money saved, and to build long term wealth (shown below).
Whether it is for an emergency fund, investing for retirement, or saving for a house, we all want to have money saved. Paying yourself first is a fast way to reach a short term or long term savings goal.
The 2nd reason to pay yourself first is that not many other savings strategies are as effective. Many savings strategies result in withdrawals because they are over ambitious.
Furthermore, paying yourself first prioritizes saving money and builds great financial habits. It establishes a business-like approach to saving money.
Related post: View yourself as a Business to Save Money
By consistently saving money, you are putting yourself in position to take advantage of compound interest. This is because you consistently have money available to dollar cost average into the market on a monthly basis.
In addition, I learned by working for financial institutions that paying myself first through automatic payroll deductions leads to money adding up quickly.
First there must be a Motivator to Save Money
Mainly, I keep myself motivated to save by being a Dividend Investor.
Since I enjoy analyzing stocks and seeing the incremental increases in income, I am motivated to save money to put towards dividend investing.
Each month I move closer towards financial independence through dividend investing and blogging, as my dividend income and blog income is higher.
The slow climb towards financial independence motivates me to save more money.
Before I had a motivator to save money, I aimlessly spent the majority of what I earned. However, I did naturally put money aside in a separate savings account. The problem was that I usually ended up withdrawing funds from it.
So, it’s important to have a goal and clear vision of what you are saving towards. It will make your savings more tangible and easier to maintain.
How do you Pay Yourself First?
First, you must keep a budget to know how much you can afford to pay yourself first. In my opinion, it’s better to start lower than it is to be overly ambitious and fail.
In the long run, depending on your age and retirement time frame, the ideal savings target should be at least 10% of all income earned.
However, if you are not salaried and your income fluctuates, this could be more challenging.
In turn, I believe it is better to start with extremely small amounts to get comfortable with paying yourself first.
Start by saving even 1% of your net income and see if you can consistently save for 1 month straight. Then move to 2% and see if you can afford to save that much in the 2nd month, and so on.
The key is to save the money before you spend it on anything else.
To consistently pay yourself first, you should either set up an automatic pre-authorized withdrawal directly to a savings or investment account, or you should budget each pay immediately.
Save in Percents instead of Amounts
Although I already touched on how much to save, I wanted to discuss how much to save in more detail.
Mainly, I recommend that you save in percentages as opposed to amounts.
For example, instead of aiming to save $100 this month, aim to save 10% of your net income.
I prefer to work with percents because it is based on individual income level, and because it is measurable therefore making it easy to move the target.
Working with percents allows you to start low and easily move the target up as you become more comfortable with paying yourself first.
To calculate 1 percent of your net income, simply punch in 0.01 * (net income amount) on a calculator.
If you want to calculate 10% of your net income, use a calculator to punch in 0.10% * (net income amount) and so on.
Never Withdraw Money
If the money you save is supposed to be for retirement or for investment purposes, it should never be withdrawn. Withdrawing money that was intended for investing defeats the purpose of investing. Investing is a long term endeavour to take advantage of compound interest. Therefore, money can not be withdrawn under any circumstances if it is earmarked for investing.
To avoid money from being withdrawn, again, it is important to work with small savings amounts rather than larger amounts. After all, some savings is better than nothing at all.
Another method to avoid withdrawing savings is to allocate other savings for spending. For example, you could divide all your savings up into percentages. You could even allocate a spending fund to yourself each month. As long as you remain within the set budget, it’s ok to spend money on things that bring value to your life. That’s what financial independence is all about anyways. FI/RE is about buying time.
Consistent Saving and Investing Over Time Will Make You Wealthy
Of course, seeing dividend income increase each month is not motivating for everyone.
A small sum of money is not interesting for everyone. Earning an average return of 7 to 10% annually on an S&P 500 Index fund doesn’t move the needle for everyone.
But if informed about saving money, maybe that would change things. What if students were educated on investing? What if they knew putting 10% of their income into an S&P 500 index fund will turn into a fortune over a 40 year time frame? Let me try to see if I can put it in terms you will understand.
Perhaps this article from The Motely Fool will convince to pay yourself first. According to the article, a $10,000 investment in an S&P 500 Index fund in 1980 would have been worth $760,000 in 2018.
Just imagine the fortune you could amass by paying yourself first each month then investing it directly into an S&P 500 Index fund like VSP.
Better yet, let’s calculate how much money you would have by using a compound interest calculator from the Ontario Securities Commission.
If you paid yourself $500 per month for 40 years, and if you invested it into an S&P Index fund, at a moderate 7% annual average return, your $500 per month over 40 years would end up being worth $1,235,771.00.
So, I think becoming a millionaire through paying yourself first is a motivator if you need one.
Paying Yourself First Eventually Becomes Natural – You don’t miss the money
A lot of people can’t afford to save because they prioritize paying off debt first. I get that. It makes sense to increase cashflow, especially if it is high interest rate debt. In fact, one of my main financial goals for 2020 is to pay off my student loan.
However, I believe it is possible to pay off debt and save a small percentage at the same time. That way you build solid financial habits and don’t have to go back into more debt if something comes up.
I’ve heard people explain that they have no money leftover to save after paying bills, which is a common problem. In their mind, they rationalize that saving money is impossible because there is already no money left.
But here’s the thing, humans adapt quickly and easily.
So, if you force yourself to pay yourself 1% of your income before you pay your bills, your spending will automatically adjust.
After a while, you will feel like you’re in the exact same situation. The only difference is that you will be saving money and will have some money accumulated in the bank.
3 Options for the Money you pay yourself first
Based on my experience in the financial industry, many people avoid saving because they don’t know where to put money.
Here are 3 options to consider for the money you pay yourself first.
Open a high interest savings account.
Build up cash and earn a low but guaranteed interest rate on the money. This is a great option if you have a shorter savings time frame or if the funds are intended to buy a house.
Open a self directed brokerage account.
If you open an account through my affiliate, Questrade, you will get $50 in free trades. Just click the Questrade ad above if you are interested in this offer. This is a great option if you want to buy your own S&P 500 Index fund, or if you want to buy your own dividend stocks to build a cash flow machine.
Call your bank to discuss investment options like mutual funds.
If you don’t feel comfortable making your own investment decisions, and if you are not happy with the low rate on high interest accounts, you can call your bank to see if mutual funds or GICs are right for you. Typically, a financial institution will have Mutual Fund Advisors that can run a risk tolerance review to determine if mutual funds are the right option. Although mutual funds carry an MER (Management Expense Ratio) fee, they are still a great option for those that don’t want to do the research. Receiving a 5% return after paying a 2% MER fee is still better than earning 1% on a GIC in my opinion.
Bonus: Pay Yourself First All Side Hustle Income and Income from OT
In addition to consistently paying myself first, one of the ways I’ve managed to advance financially is by saving all side hustle income and overtime pay.
Back when I worked in the financial industry, I consistently saved a minimum of 10% of my income through automatic payroll deductions and by budgeting my pay immediately.
But anytime I worked overtime, I pretended that money never existed and transferred it directly to my investment account.
In the same way, I typically invest all income earned from blogging as well. However, I am considering the idea of reinvesting back into the blog. Perhaps I will split the income 50/50.
Pay Yourself First – Concluding Thoughts
Ultimately, I wanted to write this post because paying myself first is the best way I know to save money.
And I have alluded to paying yourself first several times in the past in the following posts:
5 Rules to Save Money on any Income Level
View Yourself as a Business to Save Money.
All of those posts lead to the same point—pay yourself first.
In summary, paying yourself first is an easy way to save money. It refers to setting aside a portion of money earned from an income source before paying any other bills or before spending any money.
Over the course of 5 to 40 years, paying yourself first can be a way to build incredible wealth. At the very least, it’s a great way to reach financial independence and provide yourself with more financial freedom.
Questions for the readers: Do you pay yourself first? Do you use a different strategy to maximize savings? Has Coronavirus changed your savings strategy?
I am not a licensed investment or tax adviser. All opinions are my own. This post contains advertisements by Google Adsense. This post also contains internal links, affiliate links, links to external sites, and links to RTC social media accounts.
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