How to make 'pay yourself first' work for you
A Method to Guarantee Savings
by Gary Foreman
Compound Interest for Poor People
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Dear Dollar Stretcher,
Some months I can save some money and some I can't. I have heard the saying "always pay yourself first". When I do that it seems that I have to withdraw that money later on in the month to pay the bills. So how does this actually work? Should I always pay myself first? Any help would be appreciated.
James is trying a strategy that many people use to force themselves to save money. Instead of saving whatever is left at the end of the month, they 'pay themselves first' at the beginning of the month. And, surprisingly, there are a lot of families that swear by this method.
Why does it work? It seems that in nature certain events will continue until they run out of fuel. Wild fires are an example. They will continue burning until there's nothing left to consume.
Your expenses can work the same way. Many families will continue spending until all the money is gone. No matter how much money comes in some bill or new purchase will take it. Raises and bonuses all seem to vanish without a trace.
In other families expenses will consume all the money and the credit, too. Again, there will never be any money available after all the monthly minimums are paid.
Paying yourself first turns this problem into an advantage. If you take 1% of your income and put it in a savings account at the beginning of the month, the amount of money available for spending is less. At the end of the month you'll wonder where all the money disappeared. Just like you do now. Only this time you'll know where at least 1% of it has gone. It's sitting in a savings account earning interest.
For some people this plan works wonderfully. Their spending seems to automatically adjust without any real effort. They have a little less in their pockets and so they spend a little less. One less candy bar or impulse buy. It just seems to work out. Gradually they begin to accumulate savings. Unfortunately, James doesn't appear to be one of those people.
Remember, the idea of 'paying yourself first' doesn't create any magic. You'll still get a bill from the electric company each month. And they'll expect you to pay it.
James' problem could be in a couple of places. Perhaps he's getting to the end of the month and won't cut back on unnecessary expenses. A certain amount of self-discipline is required. You need to resist that candy bar. Empty pockets are an acceptable part of the deal and an incentive to stop spending.
Another possibility is that James has tried to save too much. It could be that he hasn't left enough money to pay for the basic monthly expenses. In that case, he'll either need to make some adjustments to his basic expenses (like selling a second car) or plan on paying himself less each month.
Unexpected repairs and expenses could also be sinking James' plan. You know the kind I'm thinking of. The ones that we all know will happen. We just don't know when or how much they'll cost. Home and auto repairs are often the culprit.
Your budget plan needs to cover this type of expense. Put some money away each month for these 'big hit' expenses. If your car is getting old, protect yourself by putting $100 away each month. You'll need it for that 'unexpected' $1,000 repair bill.
Where James puts his savings is important, too. It's really wise to have two savings accounts. One that's readily available for those big hit expenses. Don't use this money for a fishing boat or a new spring outfit! It's for repairs and expenses that you cannot avoid.
The second savings account is your long-term savings. It should be harder to get at. Only take money out in a true emergency. This money should be for long-term goals like a college education or retirement.
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There's a question that James didn't ask that could affect his success. That's whether it's better to put money away in savings or to pay off credit card balances first. Does it make sense to put money in a savings-type account earning 6% when you'll be paying three times that much in interest on your credit card balance?
Some people think so. They believe that once you've started to save money you'll continue to save. And there's some truth to that. Using your savings account for the unusual expenses gets you out of the habit of reaching for a credit card when a crisis occurs.
But, it does seem a little crazy to be borrowing money at a higher interest rate than you're getting on your savings. Achieving a debt-free lifestyle is important, too.
There's another way to look at the issue. Reducing your debt is actually a way of saving money. For every dollar that you repay this month, you'll reduce next month's interest charge. So you've really saved money by paying part of your credit card balance.
Sure, the next time your car breaks down you'll probably need to pull out the plastic to pay for the repair. But, if you've developed the habit of reducing that balance each month, you'll get right back on track.
Use these guidelines to choose the best plan to pay off your credit card balances.
One final thought. Starting a 'pay yourself first' program is always easiest when you get a raise in pay. Just take the increase and put it in your savings account. You'll still have the same amount of money available as you did last week. But, don't let the lack of a pay raise keep you from starting. You can begin with $5 this month. Most of us spend that much impulsively sometime during the month.
Should James continue to pay himself first? That depends on what he hopes to accomplish with it. If he's looking for the strategy to magically reduce his mortgage payment he'll be disappointed. But, if he's hoping to give himself that little extra incentive to reduce expenses at the end of the month he'll do quite well.
Reviewed August 2017
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.
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