What does it mean to pay yourself first?

One of the main principles in personal finance is “paying yourself first.” This applies not only to self-employed individuals. Even if you work traditionally, you should plan to pay yourself first because this advice isn’t really about getting a paycheck.

What does it mean to pay yourself first?

“Paying yourself first” means that you should prioritize your savings and investment accounts. You are paying your future self by saving for your long-term needs and expenses. For example, paying yourself first can include:

• Putting money into your retirement accounts, such as a 401k or Roth IRA
• Buying insurance, including life insurance and long-term disability care
• Contributing to a health savings account
• Establishing an emergency fund
• Paying down debt

When you pay yourself first, you prioritize your long-term financial well-being. Instead of only focusing on immediate needs like bills or entertainment, you are saving for your future self before any other spending.

Why is it important to save first?

Your expenses can be divided into two categories:

• Mandatory expenses: bills you must pay such as rent and utilities; things you need to live healthily like food or medicine; and things you need to do your job like work attire or internet access.
• Optional expenses: variable costs that are not mandatory, such as entertainment, clothing, travel, home decor, new electronics, dining out, streaming service subscriptions, and gym memberships.

When you save only what’s left at the end of the month, you are placing savings in the second category: it becomes an optional expense that can change each time. Sometimes, saving might not happen at all depending on your other spending. If you only think about saving after all other expenses have been paid, it’s easy to end up with nothing to save.

However, if you prioritize contributions to savings and long-term planning first, saving becomes a mandatory expense. You treat saving like any other bill that must be paid regardless of circumstances. By paying it first, you are deciding that your long-term financial well-being is the most important bill you pay.

Why does this method work?

This method increases the likelihood that you will save a substantial amount. It transforms saving from a desire into a necessity. Only after you have paid your mandatory expenses, including long-term savings and insurance, will you know how much you have available for optional spending.

The order is important for another reason: it may be difficult to cut out things like a streaming service subscription or a gym membership in order to contribute $400 to your retirement account each month. But it’s easy to cancel a streaming service subscription or gym membership in order to pay rent. When you save before paying your other bills, you put your other mandatory expenses at risk. This makes it more likely that you will cut optional expenses to continue saving.

How to start paying yourself first?

It can be overwhelming to start paying yourself first when you feel like you are already struggling to keep up with your bills and other spending. However, if you break your goals down into manageable steps, it will be easier to start saving.

There are a variety of ways to do this.

• Automate savings: Not all the money you receive in your paycheck must go to the same place. If you earn enough but find it difficult to save, you can automate it by directing your paycheck to different accounts.
• Pay down debt
• Debt First: If you have high-interest debts like personal loans or credit card debt, focus on paying those debts off first. Otherwise, the interest payments will continue to erode your ability to save.
• Pay Upfront: When purchasing life insurance or disability insurance, you can make monthly payments, or you can pay the full year’s amount all at once. If you want to pay yourself first, paying annually might help.
• Start Small: Paying yourself first doesn’t mean you need to suddenly open multiple savings accounts and buy numerous insurance plans. If you haven’t saved anything yet, you should start small. You can start building your emergency savings account with $10 at a time. As long as that $10 goes out first before any other bills, you’ll start making progress.

To increase your savings, you may need to find ways to get a second job or work part-time and cut spending. Even if you don’t have employer-sponsored retirement accounts, you can open an IRA account through a broker or bank. Some of these accounts may have a minimum initial deposit. To save that amount faster, you can put your savings in a high-yield savings account where it will earn interest.

As long as you make these payments and transfers before you spend any money on other expenses, you are starting to pay yourself first.

Source: https://www.thebalancemoney.com/what-does-pay-yourself-first-mean-453696