Why Should I Pay Myself First?

Why Should I Pay Myself First?

It’s a good way to save for the future

Why Should I Pay Myself First?

SrdvanPav / Getty Images

Reviewed by Marguerita Cheng

It’s the golden rule that will set you apart from people who are just scraping by from month to month: Pay yourself first.

It means setting aside a realistic portion of your income every time you get a paycheck and before you start spending it on anything else.

The first goal is to save enough for an emergency fund that will cover the cost of a crisis. Keep saving and it will turn into a fund that can be tapped for other needs and wants.

Key Takeaways

  • You can pay yourself first by saving as little as $50 to $100 each payday in a savings account, a short-term certificate of deposit (CD), or a retirement account.
  • Set aside the amount you’ve committed to saving before doing anything, even buying groceries.
  • The only higher priority is paying off high-interest credit card debt. You could end up paying more in interest than you save.

What Does It Mean to Pay Yourself First?

Paying yourself first is a pillar of personal finance. The concept is simple. By paying yourself first, you’re socking away some cash for the future, whether in a regular savings account or a retirement account. Do this before you do anything else, whether it’s paying bills, buying groceries, giving your kids their allowance, or purchasing a new TV.

Thinking of personal savings as the first bill you must pay each month will help you build significant wealth over time. By starting with a small amount, say $100 each payday, and using automatic payroll deductions, you probably won’t even notice the withdrawal after a few months. Even if you start with $25 or $50 a month, you’re a step ahead of the game. Eventually, as your salary rises or you tighten your monetary belt, you can increase the amount you set aside.

This strategy is also a good way to pay for planned larger purchases. Do you need new tires for your car in six months? Are you hoping to go on a really nice vacation? Do you want to save up for your child’s education?

By paying yourself first, you’re more likely to have the money for these things when you need it. You won’t have to scramble at the last minute or rely on a high-interest credit card.

“Pay yourself first” can also be a strategy for meeting unexpected expenses, like a leaky roof or a costly car repair.

How to Pay Yourself First

The easiest way to save is to open a savings account at the bank where you maintain a checking account. This gives you a convenient way to make transfers or deposits as soon as you get paid. Make it an automatic transfer, either for every payday or once a month, whichever works for you.

The other option is to open an account at an online-only bank. These generally offer higher interest rates than brick-and-mortar banks. Since it’s not tied to your checking account you’ll be less tempted to use it without a good reason.

If you have access to an employer-sponsored retirement plan such as a 401(k), contribute to that instead of a savings account. Your money will accumulate tax-free, and many employers will match your contribution, so you’ll get a little extra.

If you don’t have this option, set up an individual retirement account (IRA). If you’re self-employed, consider a SEP IRA, SIMPLE IRA, Keogh plan, or a one-participant 401(k).

You might also consider certificates of deposit (CDs), which allow you to put your money aside at a set interest rate for a specific period of time—anywhere from a few months to a few years. CDs usually require a minimum deposit, so you may need to save for a while before you can invest in one.

It’s All About Psychology

Building savings is a powerful motivator. You’ll get the satisfaction of seeing your balance grow month after month. When you prioritize savings, you’re telling yourself that your future is the most important thing to you.

Money may not buy happiness, but it can provide peace of mind because it gives you a greater ability to cope with adversity.

When you develop a routine, you’re likely to stick with it. The human mind craves structure and a sense of discipline, even if you live on the wild side once in a while. When you start saving every payday and adhere to that routine, there’s less chance that you’ll stray.

Deal With Your Debts

Remember not to neglect your liabilities. If you’re swimming in credit card and personal loan debt, get that under control or pay it off completely even before you commit to saving every month.

Compare the amount of monthly interest you’ll be earning on your savings accounts with how much you’ll be paying in interest monthly on your debt. If the latter exceeds the former, you should pay off the debt first. You don’t want your debt to cost you more money than you save.

What Does Pay Yourself First Mean?

Pay yourself first is a strategy for maximizing savings over time by setting aside a portion of your monthly income in savings before you do anything else with the money, whether it’s paying your mortgage, buying groceries, or signing up for yet another streaming subscription.

How Do You Pay Yourself First?

You need to open a savings account and should automate your regular transfers so you aren’t tempted to spend the money instead. It can be anything from a simple savings account to an employer-sponsored retirement plan.

The kind of account you choose will determine the growth potential of the money you put into it, and the ease of access to your savings. A retirement account has the potential for far greater growth over time, but withdrawals before you reach retirement age can come with stiff tax penalties.

Are There Circumstances in Which Paying Yourself First Is a Bad Idea?

If you are carrying a lot of high-interest debt on credit cards or loans, you should pay those off or at least pay them down significantly before you embark on a pay-yourself-first plan. Otherwise, you could end up paying more in interest on your debt than you earn from your savings, putting you further behind.

The Bottom Line

Paying yourself first encourages sound fiscal habits. By automatically deducting a portion of your income, you can set the money aside before you can find ways to spend it.

Still, it’s important to be practical. It’s no good saving money regularly when you have credit card debt that’s weighing you down.

Set a realistic savings goal, and stick with it.

Read the original article on Investopedia.