Sometimes I will read the same piece of advice across a dozen personal finance books and a host of personal finance blogs. My brain will automatically start pushing that to the back of my mind as common knowledge.
And then, sometime later, I will be interacting with someone in the real world and remember that it is not common knowledge. I will remember that I am a weirdo and normal people don’t spend their time reading personal finance books for fun.
One such piece of advice is to pay yourself first.
What is paying yourself first?
Paying yourself first means that as soon as you receive your paycheck (or before, if possible) you divert some of that money out of your checking account and into an account that you will not spend in the short term.
If you have a 401(k) at work, then you are familiar with the concept. You designate a percentage of your paycheck that you want to set aside. When pay day comes around, the percentage that you designate goes straight into another account and the remaining money goes into your checking account.
If you don’t have a 401(k) at work, or even if you do, you can set up a similar mechanism with an IRA. First, open an IRA. Next, set an automatic transfer of a set dollar amount to go from your checking account to your IRA every pay day.
Once the money is set aside, you are far less likely to spend it. The 401(k) and Traditional IRA add penalties to the withdrawal of money from those accounts to ensure this, but the fact that the money is out of sight will often have the same effect on its own.
If you are maxing your retirement accounts already (Nice work! High five!) you can do the same thing with a taxable investment account.
If you are saving for a short term goal or building an emergency fund, then you can do the same thing but have the transfer go into a savings account.
Why does it work?
25% of households making over $100,000 live paycheck to paycheck and don’t save any money. $100,000 is the 75th percentile of income in the United States. This means that three quarters of the country manages to live on less than $100,000 per year, and yet a significant portion of those that make more than that still can’t save.
Often our spending expands or contracts to fit the amount of money available to us. The less we have, the more cautious we are about spending it.
If you plan to save whatever is left over at the end of the month, you may encounter a lot of months without any money left over.
By paying yourself first and making your savings a priority, you are creating an artificial scarcity that will allow you to adjust your spending as the month goes on. You will likely be more conscious and less wasteful in your spending.
Most importantly, you will actually be able to hit your savings goals. If you want to be able to buy a car or a house or pay for a cool vacation, you can figure out how much you need and set up a plan to save.
Want a new ride? Make it happen. Working on a down payment? You can get it done. Want to go to Europe? Go for it. It is just a matter of prioritizing your future goals and planning to achieve them.
You can afford it!
It is easy to brush off this advice. Maybe you don’t want to cut down your spending because you feel it will be depriving yourself. Maybe the savings goals seem overwhelming and you think that the little amount you could put away wouldn’t make a difference anyway. Maybe you think you are doing fine with your savings at the end of the month.
Humor me and give it a try.
You can start small and build over time. Set up an automatic biweekly (or whatever you pay schedule is) transfer of any amount of money into a savings or investment account. Any amount! This will help set up the process, which will make it easier to increase your contribution later, and it will help you get used to the concept.
If you find that your spending adjusts and you don’t miss that small amount of money then try increasing it bit by bit over time.
If you hit a point where you can’t save any more then just leave your contribution rate alone, no matter how small it is, until you get your next raise. Any time you get a raise, increase the amount of money you are paying yourself by at least half of the new money. Because it is new money, you will get to enjoy the part of the raise that ends up in your checking account without missing the rest.
This can be a powerful tool for increasing your savings and financial stability without negatively affecting your lifestyle.
You make more money than you think you do. Keep some of it for yourself.