A fundamental lifelong principle in personal finance is to pay yourself first. That is a systematic and automatic savings plan where you contribute to your retirement or investment savings account before anything else.
It’s crucial to set up an automatic savings plan. Start by establishing how much you can afford to save without significantly affecting your budget. Then set up a pre-authorised contribution amount periodically from your bank account into your retirement or investment account.
All these activities happen before you embark on spending a penny for your monthly expenses.
How paying yourself first works with an emergency savings plan
Treat a periodic savings plan as an expense similar to essential and recurring monthly expenses. Suppose your monthly net income is $3000. You have established your monthly budget for savings of $400 per pay period. Your budget will look as follows:
- $400 will be an automatic contribution to your retirement or investment accounts, such as an RRSP (Canada), a 401(k) or a Roth IRA.
- Make a $100 periodic contribution to high-interest savings account with a financial institution as an emergency fund. Ensure funds are liquid and easy to withdraw when an emergency occurs.
The Remaining $2500 is utilized for regular monthly expenses such as:
- Mortgage payment or rent
- Car loan payments
- Life Insurance
- Credit card monthly payments
Life happens, but if you stick to the savings plan you can achieve your monthly savings goals before you meet your regular expenses. If you attempt to first pay for regular expenses ahead of paying yourself first it’s very likely that there won’t be any money left over for investing.
Pay yourself first works because if you can’t see the money saved, most likely you won’t miss it. They say out of sight, out of mind.Click here to check out the savings and interest calculator.
Set up your investment account in a way that it’s a huge hassle to withdraw funds from it. Get an account that requires you to go to the bank to sign for withdrawal papers. This will reasonably discourage you from withdrawing the funds.
The hassle works in your favour as it keeps the funds intact and as a result, they will continue to grow uninterrupted.
Why doesn’t everyone do it?
Most people don’t pay themselves first. They think they can achieve their monthly savings goals by putting aside what’s left after their monthly obligations. For this reason, they usually run into a savings shortfall, which can lead to debt accumulation. In addition, the mentality of not making enough to save seems to be an obstacle in the quest to paying yourself first.
To the contrary, you can start with a small savings amount, like 1% of your income. In the long run, it’s surely easy to commit to such a small figure. Ultimately as your pay increases or debt decreases you can certainly raise your periodic savings amount.
We live in a world where most people are seeking instant gratification. Generally, people are unwilling to consume less now for a more financially secure future. But if you pay yourself first, you are one of the few who gives up instant gratification for a secure financial future.
What happens if you are not on track?
In the event that you lose your job, this will severely decrease your income. Unfortunately, such circumstances can happen. As a result, you may be unable to keep up with your monthly investment goals.
That’s okay, don’t sweat too much about it. Just suspend your savings until the situation normalizes. Once you have achieved stabilization, make the necessary adjustments to resuscitate the savings program.
What if you are employed by a small business?
What if you work for a small firm that doesn’t do automatic payroll deposits into a bank account because the cost is too prohibitive?
Simply arrange with your payroll to periodically cut a cheque in your name and mail it directly to your bank. A bank officer will regularly deposit it into your investment account. This way you won’t feel the deductions, but you will see the investment growth.
Matched company contribution
If your employer offers saving plans such as a 401(K) or an RRSP (Canada), I suggest you register the day you become eligible, especially if the company matches your contributions. Eligibility is attained right after a probationary period between 3-6 months of continuous employment.
Matched contributions are free money from your company. If you’re a participant in a matched contribution plan the policy may stipulate, for instance, that for every 50 cents of your biweekly contribution, the company will match it. Consequently, you will be getting a free 50 cents. Over time the investment grows particularly if you select to contribute towards the company’s common stock.
The pay yourself first plan leads to net worth growth
Getting into the habit of consistently investing your income requires discipline and absolute commitment.
In most cases, how much money you periodically make does not lead to wealth accumulation.
On the contrary, net worth growth is entirely dependent on how much you save and invest. Furthermore, investing is crucial to building financial independence and resilience when disaster strikes.
An unconventional saving and investing strategy
Saving while you spend
Although it sounds counter-intuitive, you can certainly save while you spend. It’s an alternative option to achieve your savings goal whilst you’re spending.
Achieving a savings goal during spending is very simple to set up. Your bank can round-up every purchase made to the nearest $1.00 or $5.00. Suppose you set up rounding off to the nearest $5.
You could carry out as follows:
- You spend $6.50 to buy a cup of coffee using your bank card.
- Round off every purchase made with the debit card to the nearest $5.00.Your chequing account statement will show a $3.50 deposit into your savings account and $6.50 payment for coffee.
- Gross deductions from your bank account consists of $6.50 for coffee and $3.50 deposit to the savings account. In total, the amount withdrawn from your account is $10.00.
Once you’ve achieved your savings target. Consequently, arrange to automatically transfer funds from the savings to the investment account set up in the scenario above.
All things considered, irrespective of age, you should make it a priority to develop a regular savings plan. As a rule, establishing this habit early on can lead to increased financial security and a significant increase in net worth later in life. On the other hand, if you got a late start for whatever reason. I recommend you do your utmost to keep paying yourself first until you meet your set financial goals.
What do you think? I would love to hear your thoughts down in the comments section!
I’m an extreme personal finance enthusiast and have been working in the financial industry for over a decade. The blog was started to further explore and share personal finance knowledge with the world.
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