What is the “Pay Yourself First” budget?

The “pay yourself first” budget works exactly as it sounds: you fund your savings goals first, and then use the remainder of your paycheck as you see fit. While there are many benefits to this type of budgeting, there are also drawbacks you should be aware of.

Definition and Examples of the “Pay Yourself First” Budget

The “pay yourself first” budget is a reverse budgeting strategy where you save a portion of your income first – likely treating your savings like a bill – and then use the rest of your money to cover expenses and spending as you see fit.

Alternative name: Reverse budget

The “pay yourself first” budget is easier than other types of budgets because you don’t need to spend time tracking your expenses. As long as you prioritize saving, cover your bills, and avoid borrowing more, you’ll be fine.

For example, let’s say your goal is to save 20% of your income. So you save 10% for retirement, 5% in an emergency fund, and 5% for a vacation fund. Now you can spend the remaining 80% on needs and wants.

“My favorite budgeting method is reverse budgeting,” says R. J. Weiss, a certified financial planner and founder of The Ways to Wealth. “This method means you fund your goals first (like savings, travel fund, home payment, etc.) and then you can spend what’s left. This way, the person takes care of their goals, ideally with automatic transfers, and then they can spend the rest.”

How Does the “Pay Yourself First” Budget Work?

When you pay yourself first, you’re automatically allocating a set amount of money to your financial goals as soon as you receive your paycheck. This way, money is directly transferred to your savings account, credit union account, 401(k) retirement account, and any other investment account first. Then you can spend the rest of your paycheck as you wish.

The “pay yourself first” budget is a type of low-maintenance budgeting because it doesn’t require you to track every penny you spend. As long as you meet your savings goals and don’t overdraw your checking accounts or take on more debt, you’re doing it right.

Note: The 50/30/20 method and the 80/20 method are two types of “pay yourself first” budgets. With both of these methods, you save 20% of your income and use the rest for wants and needs.

How to Build a “Pay Yourself First” Budget

Building a “pay yourself first” budget is a simple process that consists of five steps.

1. Create a Budget

You don’t need to track your income and expenses precisely with a “pay yourself first” budget. However, you need to create a budget so you know how much you can pay yourself. Start by reviewing your bank statements and credit card statements and total your expenses. Compare these totals to your total income to see how much extra money you have in your budget.

Note: Expenses can change from month to month, so you can gather your purchases for the past three months and then calculate the average to get a more accurate number.

2. Determine Your Savings Goals

Now it’s time for the fun part, where you decide what you want to do with your savings each month.

Returning to the previous example, if you have $400 left in your budget, you might decide to put $200 in your retirement account, $100 in your emergency fund, and $100 to pay off your credit card debt. How you spend the rest of your paycheck is entirely up to you.

3. Set Up Automatic Transfers

Once you’ve determined your savings goals, set aside an hour or so to set up automatic transfers to fund your savings goals. Set up automatic transfers to your checking accounts, savings accounts, credit union accounts, and other investment accounts to coincide with your payday. You can also set up a 401(k) withdrawal with your employer.

4.

Spend the Rest of Your Money as You Wish

The biggest benefit of the “pay yourself first” budget is that you don’t waste time or mental energy trying to make sure you’re not overspending in certain categories. You have the freedom to spend the rest of your paycheck on your terms.

5. Make Adjustments as Needed

If you find that you don’t have enough money to cover all your wants and needs each month, look for ways to cut back on discretionary purchases or reduce fixed expenses (such as moving to a cheaper apartment or negotiating bills, for example). Also, look for ways to increase your income.

If you’ve followed these steps and are still in the red, it might be time to scale back some of your savings and debt repayment goals until you achieve balance in your budget. You can resume those goals once your financial situation improves a bit.

What is the Ideal Percentage to Pay Yourself?

When creating a “pay yourself first” budget, one of the first questions you might have is, “How much should I pay myself?”

Most experts recommend saving at least 20% of your income each month. But in real life, things aren’t always that easy. You may be living paycheck to paycheck or be at a savings point of 5% of your income – and that’s okay. Saving anything, even if it’s just a few dollars a month, is better than saving nothing at all.

Even practicing paying yourself first each month can have a significant impact when your situation improves and you eventually get the chance to save more money.

Advantages and Disadvantages of the “Pay Yourself First” Budget

Advantages

• A type of low-maintenance budgeting: With the “pay yourself first” budget, you don’t have to worry about whether you’re overspending on housing or if it’s okay to spend a lot on popcorn at the movies. You can spend the rest of your paycheck however you like once you’ve paid yourself first.
• Priority on saving first: The main goal of the budget is to help you achieve your savings goals and live your life in the best way possible. With the “pay yourself first” budget, you make sure you’re hitting those goals from the start.
• Automatic budgeting: One of the golden rules of the “pay yourself first” budget is to set up automatic transfers for all your savings goals so that money is moved from your checking account the moment you get paid. Out of sight, out of mind.

Disadvantages

• Not ideal if you’re living paycheck to paycheck: You may not have enough room in your budget to comfortably pay yourself first without overdrafting or borrowing. In this case, you might consider using a zero-based budget or a financial condition budget first, then transitioning to a “pay yourself first” budget once you have some flexibility in your budget for saving.
• May lead to unchecked spending: When you pay yourself first and spend the rest of your paycheck however you want, you may miss opportunities to optimize your spending and reach your savings goals faster.

Main Takeaways

• The “pay yourself first” budget is a budgeting method where you allocate a certain amount of money to your savings goals first, then use the rest of your paycheck as you wish.
• The “pay yourself first” budget is easier than other types of budgets because it doesn’t require you to track every penny you spend. As long as you are meeting your savings goals and not overdrawing your checking accounts or getting deeper into debt, you’re doing it right.
• The “pay yourself first” budget works best for those who have a good understanding of their spending and saving. It may be ineffective if you’re at risk of overdrawing accounts or increasing your credit card balance.

Source:

https://www.thebalancemoney.com/the-pay-yourself-first-budgeting-method-453955