Pay Yourself First: Definition and How it Works (2024)

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• Paying yourself first means saving money before using it for bills and other spending.
• This approach to budgeting protects you in financial emergencies and provides for future opportunities.
• You can set it up using automatic transfers from your paycheck to dedicated savings accounts.

When it comes to your money, earning it is only half the battle. Once you've got the cash flow, putting a plan in place to manage, save, and invest it is crucial to your long-term financial well-being.

Often described as "reverse budgeting," paying yourself first ensures that saving is not only accounted for early and reliably, but that it becomes a priority. Your savings turn into a monthly expense — paid to you, by you.

What does pay yourself first mean?

Definition and explanation

Developing a budget doesn't have to be difficult. One of the most popular methods for doing so is built around a simple principle: pay yourself first.

"Most people spend their money, and then say 'Oh, I need to save.' Then at the end of the month, they just forget and they never really save," says Erik Sussman, a certified financial planner and CEO of The Institute of Financial Wellness. "So instead, we implement pay yourself first. That means before you pay the light bill, before you pay your mortgage, before you pay for your clothing, you pay yourself first."

At its core, the pay-yourself-first method means having a specific amount of your paycheck set aside and saved every month before it can be spent on anything else.

"In essence, it's automating a saving strategy, or putting a plan specifically around savings," explains Autumn Lax, a CFP professional at Drucker Wealth Management.

Benefits of paying yourself first

Picture this: you've put all of your extra money toward paying down your mortgage as fast as possible. On the day you make your last payment, a tree falls on your roof. Suddenly you're not only back in debt, but you're in high-interest debt because you had to pay for the repairs with a credit card. It's this kind of scenario that makes paying yourself first so important.

As Sussman explains, even if you're putting your money toward a "good" goal, it doesn't mean much if something unexpected occurs.

"In an emergency, you can't call the loan company and say 'Hey, can you send me back that $10,000 extra that I sent in?'" he says.

Still, it's not just emergencies that paying yourself first protects against. It's also there for opportunities.

"You're much better off having the money in your possession," Sussman says. If you're putting your savings in some kind of growth-oriented fund, "you're earning 8% or 9%," he explains.

"That difference over a long period of time is a lot of money." This can be particularly beneficial for long-term financial goals like retirement.

And simply put: One day you'll need the money you're saving today, so it has to be a priority. As Lax says: "Once you retire, there's no more money coming in. And the only way that you'll generate an income is based on the assets that you've saved."

How to implement the pay yourself first strategy

1. Budgeting for pay yourself first

"First thing you've got to do is write out a game plan," Sussman explains.

Paying yourself first doesn't mean you neglect all of your other financial responsibilities in pursuit of your savings goals, so you've still got to account for them. Lax suggests reviewing your spending over the past few months, itemizing it, and figuring out your average spending by category.

It can help to start with your recurring and required expenses — for example, rent or mortgage, food, minimum loan payments, medicine, and bills. Once you calculate that minimum amount you know you'll have to spend every month, you'll be better equipped to determine how much you can afford to save each month.

2. Prioritizing savings over discretionary expenses

In an ideal situation, you should aim to save 20% or more of your income, and 10% at a minimum, Sussman says.

Let's say you bring home $3,000 per month. A good monthly savings target would be $600, or 20%. If you've calculated your minimum monthly expenses to total $1,400, for example, saving $600 per month is more than doable. It even leaves an additional $1,000 to spend freely or put toward other goals like paying down a mortgage.

However, with these numbers, you could just as easily decide you'll save $1,000 per month and put the $600 toward your discretionary spending. Ultimately, finding that sweet spot is going to be unique to each person based on their lifestyle, income, expenses, and goals. As a general rule, aim for 20% and adjust from there. If 20% isn't achievable, it may be worth looking into ways you can minimize your spending or increase your income.

3. Clarifying your goals

Once you know how much you're going to pay yourself each month, it's time to figure out where that money should actually be going.

"If you have no emergency cash reserve, I see that as a priority," Lax says. "The next place I would look to save is in tax-efficient vehicles like retirement plans."

Another way to look at your savings is by timeline. "Break up your goals into short-, mid-, and long-term," says Sussman. Short-term could be an emergency fund if you don't have one. Mid-term might be purchasing a house. Long-term could be retirement. "You need to portion out how much to put in each of those buckets," he explains.

After determining how much you're saving every month, then delineate how those savings are specifically divided.

4. Setting up automatic savings

With all the numbers figured out, put your plan into action. One of the easiest ways to "pay yourself" every month is to automate the transfer from your checking account to the appropriate savings vehicle, like a high-yield savings account.

"If you just automate it, it happens without having to think about it," Lax says.

Not only does it make saving self-regulating, it also removes the money from your checking account before you can consider spending it. Some employers make it easy to deposit percentages of your check into different accounts. If that isn't possible, you can usually set up these transfers through your bank.

The impact of paying yourself first

Though paying yourself first is generally cited as a good habit to implement, like anything, there are pros and cons to consider before making any changes to your financial strategies.

On the plus side, paying yourself first "makes sure your money is going to the right places," Lax explains. And when it's automated, it's a generally low-maintenance system that accounts for all of your financial responsibilities.

It's also helpful when you're setting and visualizing goals. "You can actually see and work toward them," Lax says.

However, paying yourself first doesn't always make sense and can end up working against you if you have high-interest debt. Outside of building an emergency fund, "if you've got all of these bad debts, you don't want to pay yourself first," Sussman says.

The reason for this comes back to simple mathematics. "If you're paying 20% interest on a credit card, there's no realistic investment you can put your money in to get more than 20%," says Lax. "So you're kind of working against yourself."

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