You may always say that you'll up your retirement contributions (next pay period, you promise!) or stash a little extra in your emergency fund, but somehow another month passes and you still haven’t done it.
The problem is likely that by the time you’ve paid for everything else—rent, groceries, utilities and maybe even a few dinners out—you often don’t have enough left to add to savings ... at least not until your next paycheck. And so the cycle goes.
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If this sounds familiar, it could mean you're not in the habit of paying yourself first, which isn't the same as spending money on yourself. “Paying yourself first means saving before you do anything else,” says David Blaylock, CFP® with LearnVest Planning Services. “Try and set aside a certain portion of your income the day you get paid before you spend any discretionary money. Most people wait and only save what’s left over—that's paying yourself last.”
In other words, the goal of paying yourself first is to help make sure your future self’s key financial goals are covered, including building up an emergency fund, contributing to retirement and saving for any other long-term goals, like a down payment on a new home. Bottom line: It’s important to have these bases covered before you spend any portion of your paycheck on, say, a happy hour with friends.
Of course, this means you need to get into the mind-set of paying yourself first—and that can be a challenge for even the most money-savvy among us.
Why It’s Important to Pay Yourself First—Now
“[Paying yourself first] is a tactic that’s been talked about and promoted for a long time, but the country's savings rate doesn’t indicate enough people are doing it,” says Chad Nehring, a CFP® and partner with Conceptual Financial Advisors in Wisconsin.
According to a recent Bankrate survey, only 23% of Americans have enough emergency savings to cover six months of expenses (the amount many advisers recommend for financial security should something unforeseen happen)—and 26% have no emergency savings at all.
Meanwhile, another poll by the Employee Benefit Research Institute shows only 18% of workers are very confident they’ll have enough money saved for retirement. Combine that with the pending Social Security shortfall and the fact that very few employers outside of the government offer pensions anymore, and the take-away is clear: Your nest egg is your responsibility.
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The sooner you get started, the better off you’ll be. Wait too long, and a car repair, medical bill or layoff could throw your future goals off track.
You’d think this would be enough to scare most people into saving better, except there’s the little matter of, well, just about everything else your paycheck has to cover: 53% of workers in the EBRI poll say that the cost of living and day-to-day expenses are the biggest obstacles to saving.
But the sooner you get started, the better off you may be. Not only will you be able to take advantage of compound growth to help grow your money faster, but you’ll also help ensure that your financial goals are getting funded before life happens. Wait too long, and a major car repair, big medical bill or layoff could throw your future goals off track.
“Bills shouldn’t be a surprise, but there are going to be things you can’t control,” Nehring says, adding that he and his wife are constantly dipping into their own emergency savings because of the unexpected. “Having [that] money available prevents panic.”
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The Beauty of Setting—and Forgetting—Your Savings
It can be hard to transition to a pay-yourself-first mentality because “there’s an unwillingness to do something different if we’ve been doing it the same way for some time,” Blaylock explains. “So it’s like challenging the status quo.”
But instead of waiting for saving to feel like second nature, consider putting as much as you can on autopilot. To do this, Blaylock and Nehring both say that the key is to automate, automate, automate.
So consider direct-depositing contributions to a retirement account before that money hits your checking account. And if your employer allows for multiple automated transfers, you can also have a set amount transferred into emergency savings or another account earmarked for a specific savings goal.
“Paying yourself first takes a long time to develop [as a habit], because there isn’t immediate gratification,” Nehring says. “But automatic deposits [from] payroll is a great first step.”
How much you choose to put into these accounts will depend on your budget and goals. If you don’t have a budget, sit down and take stock of what your monthly fixed costs are (bills that don’t change much from month to month), as well as what flexible spending costs you typically have each month, which are expenses that tend to vary, like groceries, personal shopping and entertainment. Also take note of all your current minimum debt payments.
“Run [those costs against] your income, and determine if there’s an overage," Blaylock says, adding that this is a good starting point for seeing how much extra money can go toward pay-yourself-first financial goals.
Of course, you also have to keep in mind the timeline for when you'd like to reach a given goal. For clients who think they're not saving enough, Blaylock challenges them "to find costs they can reduce or eliminate, like a gym membership they haven't used in a while." What you save by trimming in other areas can then be transferred to paying yourself first.
"The tendency when money is coming in is to spend it. But what you should think is, ‘OK, it’s been a great month. How much do I put away for a not-so-great month?' ”
Paying Yourself First for the Self-Employed
Anyone who owns their own business knows the ups and downs of good and bad months. Admittedly, it’s a little harder to save a specific amount when you don’t know how much you’ll make from month to month.
So what do you do if your paycheck isn't consistent?
Nehring suggests setting a budget that's based on an average month. “What I try to do in the months that are better is put some of that money away [in a separate savings account], so that if I have a slower month or quarter, I can pull from that account to keep my cash flow even,” he says. “Some businesses have cycles. The tendency when money is coming in is to spend it. But what you should think is, ‘OK, it’s been a great month. How much do I put away for a not-so-great month?' ”
Another strategy is to consider putting a percentage of whatever income comes in toward your savings goals; for instance, setting aside 5% of your pay in a given month for an emergency fund.
Of course, this only works if business owners are paying themselves a salary to begin with. Many small business owners tend not to pay themselves at all—let alone first. Oftentimes they leave as much in the business account as they can, reducing their salaries to nothing.
“Just because you have responsibilities in the business doesn’t mean you can’t put aside money for you personally,” Blaylock says. “A business owner is no different than anyone else—they still have to look out for themselves as individuals."
And that's ultimately the guiding principle behind paying yourself first—putting your own long-term well-being ahead of almost every other financial situation because you are your own biggest asset.
"I always say, 'If not you, then who?' " Nehring says. "There's no one else who is going to [save] for us."
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. Unless specifically identified as such, the people interviewed in this piece are neither clients, employees nor affiliates of LearnVest Planning Services, and the views expressed are their own. LearnVest Planning Services and any third parties listed in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.