What "Paying Yourself First" Means And Why You Need To Do It
I remember a couple of years ago when the phrase, “treat yo’self” became popular, thanks to the TV show, Parks and Recreation.
While I’m all for a good treat, I really wish the phrase, “pay yo’ self first” was just as popular. Many financial gurus believe that this one practice is the key to achieving financial goals. The problem is: most people haven’t heard about it or don’t understand what it means!
So let me clear this up.
Paying yourself first is putting aside a percentage of your income into savings or investments, before you do anything else.
The idea is that every time you receive a paycheque, you first put some money towards a long-term goal, like filling out your emergency fund (if you haven’t already) or investing for retirement.
This sounds a bit counter-intuitive, as it’s common to save what’s left over after expenses, rather than save first. I used to do this, too. I remember my grandmother once asking me how much I was saving, and for a 19-year-old who had a decent part-time income and no bills to pay, I was spending wayyyyy too much and saving basically nothing (sorry, grandma)!
Thankfully, my habits have gotten a lot better since then, and getting excited about my financial future has been a big reason for that.
In fact, I’m obsessed with paying myself first now, because in my view, it’s the best way to ensure my future wealth. It’s become an effortless way to get me in the habit of pursuing what’s most important to me, rather than what’s urgent in the moment.
Why You Need to pay yourself Now
If you have a lower/ entry-level income, you might think you can’t afford to think about your financial future yet. But as I shared in last week’s post about investing in your 20s, you actually can’t afford not to. As time goes on, it only gets more difficult to save enough for your goals.
Hopefully, you’re expecting your income to increase over your lifetime. Maybe you have a number in mind that you’ve decided will be a “comfortable” salary. You’ve told yourself that once you reach that number — whether it’s $40 000, $75 000, or 6 figures — you’ll start saving. After all, by then, you’ll actually have money to set aside.
Unfortunately, it doesn’t work out that way in real life.
People who make more money don’t automatically start saving more. Instead, they usually start spending more, because of something called lifestyle creep.
Lifestyle creep is a phenomenon that happens something like this. When you can’t afford some of the things you want, you start compiling a mental list of the purchases you’ll make when you have more money.
As your income increases, you gradually phase in those things — like weekly trips to the movies or a nicer wardrobe. In other words, you start upgrading your lifestyle, rather than upgrading your savings.
As you buy more things, you get used to having them, and they start to feel like necessities. Besides, the more you become aware of what’s out there, the more expenses you start adding. Suddenly, even your higher income doesn’t feel like enough, and you have a new list in mind. And the cycle goes on.
If you don’t believe this pattern will apply to you, let me just present you with a quick statistic.
At the end of 2018, the average savings of a Canadian household was 0.8% of their income.
What does this look like in real numbers?
Well, if someone’s annual income was $25 000 after taxes, for example, it meant they saved $20 total for the year.
Twenty. Dollars. A year.
And this is the average — meaning that some households saved significantly more, but many saved less (and were probably in the negative)!
In other words, saving takes intention. There’s no magic switch that turns you onto saving, the minute you start making more money. That’s why many millionaires get into crazy debt, and people with average incomes, like teachers, become millionaires.
Unless you prioritize saving, it doesn’t happen.
Wealth-building is all about habits and behaviour. People who manage to increase their net worth actually hold on to their money, rather than giving it all up.
As a broke twenty-year-old, you might be thinking that it will be easier to start paying yourself when you get older. But our expenses naturally increase as we move onto total financial independence from our parents. So, as challenging as it might be to set money aside now, imagine the stress of just starting to save while you’re paying to maintain your household and feed your family.
But while saving takes intention and commitment, it doesn’t have to take much effort beyond that — especially if you adopt a pay yourself first model.
The trick behind paying yourself first is that the money disappears into another account before you have a chance to miss it.
After all, you can’t spend what you don’t have. Locking some money away into investments automatically allows you to avoid thinking that the money was ever available. It gets your money to start working for you right away. And let’s be honest, if you’re working, your money better work, too!
How to Pay Yourself First
So what does paying yourself first look like?
The first thing you need to do is be aware of how much you make each month. (Hopefully you already are, but not everyone is!)
If you’re self-employed or have a fluctuating income, this might be a little bit more complicated, and I will talk more about self-employment income in the future.
Next, calculate your fixed expenses, as in what you need to survive. This includes rent, bills, food, and any other recurring payments that are necessities.
Subtract your fixed expenses from your monthly income.
After this, see how much is left over. This is your “fun” money. It’s the money you can survive without, but it lets you enjoy your life.
Let’s say it’s $500. Usually, you’d spend that $500 without even thinking about it. But this month you’re going to take out $100 into an investment account first, leaving yourself with $400. Trust me, you won’t even miss that $100.
The easiest way to make sure you’re really paying yourself first is to automate the transfer into your savings/ investment account.
This means that to save $100 a month, you need to schedule an automatic transfer of $50 every other Friday (or whatever day you get paid).
If you have a variable income, like I do, you can adjust this. For example, I like to designate one client per month as my “pay myself” client. So, when I receive my cheque from them, that money always goes straight into Wealthsimple.
The point is that once you’ve put that money aside, you don’t think about it any more. It’s like you never had it in the first place. So, putting it into a less accessible account is better.
How Much Should I Pay Myself?
Paying yourself first is meant to be painless. It’s all about making saving easier for you.
I could write about how much you “should” save, but everyone I know is in a different financial situation and has a different income to expense ratio.
The main point to all of this is to live on less than you make. It’s how people get rich.
If you’re barely paying for your necessities, of course I’m not going to suggest you pay yourself first. The first thing you have to worry about is not starving and keeping a roof over your head — and then increasing your income, so that you’re not in such a dire situation.
Overall, you have to determine what you can manage, and the most important thing is to start doing something.
If you want to read more about paying yourself, check out the work of David Bach, who I’ve mentioned before as the author of one of my recommended investing resources. He promotes paying yourself the first hour of every work day, which comes out to about 12.5% of your income.
But again, start with something that makes sense to you, whether it’s 5%, 10%, or as much as 25%.
Leave a comment below with your thoughts on paying yourself first, and/or with any suggestions for future money-making Monday topics!
Now, get out and pay yo’self!