Watching my computer screen, I could see her face relax. Her shoulders went down. The stress lifted. She had a plan and she could see that it would simply work. No more stressing out every month when she didn’t meet her savings goals.
It reminded me that a process I take for granted, one that I encourage all of my clients to do, isn’t something most people know about. So I want to share it with you right now. Today we’re talking about paying yourself first.
You might have seen something about “paying yourself first” if you read books or blogs about personal finance. And you might have wondered what it’s about, why it’s important, and what the big deal is. I am a huge fan of paying yourself first as long as you do it the right way, so let me tell you what that is and why it totally rocks.
[Side note: I recorded a video on Facebook Live about today’s post. It’s at the bottom, so if you like video, be sure to check it out!]
What we usually do
Let’s say you’re trying to save money for a vacation. It’s really common to take whatever money you have left over at the end of the month and throw it towards your vacation savings, right? You might decide you want to save $500 per month and when the end of the month comes around, if you have $500 you put it in. If you have $600, you still put in the $500 and keep the rest as spending money or to put towards something else. If you only have $400 then you just save the $400 and you feel a bit sick about not meeting your goal. Does this sound familiar? It probably does because I come across this a lot, not only with my clients but in general conversations with people. “We had to put off our vacation because of a sudden xyz expense.” Totally sucks, right?
You try to “budget” better, but that doesn’t work. Your budget numbers add up, though. You should be able to easily save $500 every month. What’s going wrong? Sadly, Mickey and Minnie will have to wait another year, because you just can’t seem to save as much as you want for that vacation.
So what’s the alternative?
The basic approach
The alternative is to pay yourself – your vacation fund – first. You’ve run the numbers so you know you can afford this. You just need to stop “wasting” money on random crap. You get paid twice each month, so every time you get a paycheck, you put $250 into your vacation savings account the day you get paid. (Yeah, that got both bold and italics because it’s that important!) Then you pay the rent, the electricity, and your other bills with this approach. Whatever is left can be spent on groceries, gas, and whatever else you want.
Remember, your budget should include fun money so it’s not like you’re giving up all of your fun. You’re just making sure you don’t have to cancel the trip to Disney due to a few extra meals out and indulging in the dollar bin at Target too often. You can still do those things a bit, but with the $250 each paycheck – $500 per month – already in your vacation fund, you can’t overdo it, and that’s the key.
Let’s talk about reality
That vacation example sounds lovely, but I don’t know about you, I’ve never been saving for just one thing at a time. So let’s make it real. Let’s say Jane wants to save for a vacation. But she also wants to put money towards retirement, save towards a new car, and pay off credit card debt. Now what? This is where it gets a little more complicated, but not a lot more. After all, the old rules (aka, my Nest Egg Chick rules) still apply.
That means the first thing Jane has to do is pay off her debt. Looking at her budget, Jane figures she has $600 per month she can put towards savings. So each month, she’ll put $600 towards her credit card debt on payday in addition to the minimum payments she was already making, and she’ll and have it paid off within 6 months. Yay Jane!
Next, Jane will split that $600 between her savings goals (vacation, retirement, car.) She was also making $300 minimum payments on her credit card debt, so now she has $900 to put towards savings! Let’s assume she already has an emergency fund. That means she’s splitting the $900 between her retirement fund, her vacation fund, and her car fund. She can divide things up however she wants. Based on her needs, Jane chooses to put $200 towards her vacation, $350 towards the car fund, and the remaining $350 into her retirement fund.
Jane goes to HR at work and arranges to have money automatically taken from her paycheck and put into the company’s 401k. Then every payday, she puts $200 into her vacation fund and $350 into her car fund. The rest of the month is easy and relaxing. Maybe towards the end of the month she realizes she can’t afford an extra night out at the movies, but she doesn’t mind because she’d rather spend that money on airfare to Florida anyway.
There’s no chance Jane will run out of money for that vacation, the car, or retirement savings before the end of the month. You see how that works? It’s brilliant. When you pay yourself first then you always have the money that you want for what you want most!
One thing I love about this approach is how flexible it is. Life changes from time to time, right? Maybe Jane decides she hates taking care of a car in the city, so she sells her current car and throws her profit into her vacation fund. Now her vacation is fully funded and she doesn’t need her car fund anymore. But she’s had her eye on a new sofa for a while, and now seems like a good time to buy one. She’s also realized that at her ripe old age of 32, she should be saving more towards retirement, so Jane talks to HR again and now puts $600 towards her retirement. Then every payday she puts $300 into her sofa fund. The vacation money just sits in the account until Jane is ready to start paying for her trip. Once Jane buys the sofa, she changes her savings plans again.
Why this rocks
There are so many things I love about this approach. First, it guarantees* (minus a job loss or something similar) that you will reach your savings goals. All you have to do is keep putting money into your savings accounts on payday. Easy!
It also means you can feel confident in your approach. You won’t have to worry about spending too much on stuff you don’t care about as much, because you have already funded your savings for the month before you spend on anything else. And that means you can spend money all month long without worrying about screwing up your vacation or whatever else you’re saving for. No more stress about savings!
This is what I was noticing with my client the other day. She seemed really stressed out about putting money towards savings because she felt so guilty every time she failed to save as much as she wanted. She said that she was spending little bits of money on crap that she would be happy to skip, but in the moment it never seemed like a big deal. I laid out a plan, telling her how much money to put into each of her savings accounts every payday. And I saw her visibly relax. Because she knew that those little bits of spending wouldn’t get in the way any more. She will still have a “fun money” category in her budget – and you should too! – but she will now be aware of how much money she is spending on fun, and she can’t possibly overspend. She will have the savings that she truly wants. Because she has a plan that can’t fail.
What about you?
It’s your turn. Choose a couple of things to save for, figure out how much you should be able to put towards them every month, and plan to put that money into your savings accounts every payday. Mark it on your calendar. Put into a reminder app on your phone. It’s time to pay yourself – your future self – first!
My guess is that you’re going to fall in love with this process because by paying yourself first, you will never again get to the end of the month and feel guilty and sad and embarrassed that you don’t have the money you wanted to have to put towards your savings. Because you’ve already done it. Boom!
*Make sure you have an emergency fund. If you don’t have one, make that the first thing you save for.
Are you ready to take your financial game to the next level? Check out my workbook: 4 Fabulous Steps to Improve Your Finances!
UPDATE TO ADD: I recorded this video on Facebook Live about today’s post, so if you prefer video, check it out!