Pay Yourself First – The Simple Strategy that Works!
A commonly referenced theme in the personal finance community is the idea of paying yourself first. The essential premise behind paying yourself first: pay the future you, before bills and spending. Now before you go implement quite possibly the easiest personal finance tip ever,
Pay yourself is really simple and the best thing about it, you remove all temptation not to save, pay off debt or invest in your future. The concept is actually really simple, here is how it works in a nutshell:
Step 1: Figure out your monthly income
Step 2: Figure out how much your bills in total cost each month (Use the MLW Budget Sheet here)
Step 3: Subtract your income from your outgo
Step 4: Pay yourself a standard % of what is left over every month before ANYTHING else
Pay yourself will promote accountability to yourself. By paying yourself first, you in a sense, remove the possibility of temptation or inpulse spending. The approach requires some discipline, but with correct budgeting the idea is almost seamless.
Need to pay off debt?
Need to save for the future?
Need to invest into retirement?
You should figure out what percentage of your income you can allocate to your future and use the pay yourself first concept.
The advantage of paying yourself first, or the PYF Strategy, is the idea of security. Security for your future. It is the same concept that has allowed my wife and I to knock out our car loans, my student loans, and closing in on 6 figures of her student loans.
Keep in mind, with lots of debt and minimal savings, financial stress can lead to larger issues. Like I recently wrote about in my Don’t Compare Yourself post, when posed with the question of whether someone would rather have financial security or “stuff” most will chose security.
Yet somehow we still have a population of working class adults who live paycheck paycheck (87%) and more than 50% who don’t have $1,000 to their name.
Nest eggs are great in case of emergencies, car maintenance, appliance failure, and so on. With the expectation that at a millennial will need 1.8 million in order to comfortably retire, most people (myself included) should have implemented the PYF strategy about 10 years ago.
Read how far 1 million lasts during retirement here (spoiler – not very long).
Starting the PYF Strategy for the first time
Using some median family income and expenditure numbers from the 2014 Bureau of Labor and Statistics, here is a scenario of what the PYF strategy would look like for a couple with no kids (Let’s pretend they are both teachers, this actually about what a teacher gets paid in Northern Virginia)
Income AFTER taxes (AKA bring home): $6500
Outgo after paying the minimums on our house, utilities, student loans, insurance, and groceries: Approx $4,000
Leftover each month: $2,500
In this scenario, this fictional couple would have $2,500 each month leftover. To play it conservative, let’s say this person has $2,000 to use to pay off debt, save, or invest, they use the other $500 for spending.
The simple way to do this, is to take the amount of $2,000 and divide by the number of checks you get each month: $2,000 / 4 = $500 per check.
Pay yourself first would mean that every time this couple received a paycheck they took $500 from each check FIRST and paid off debt, saved or invested. Non negotiable. This is actually similar to what Lauren and I do, just a little different.
We live off my teacher salary and we use 100% of her DPT salary to pay off student loans. It’s how we have been able to pay off $109,000 in debt.
What do you do with all this money?
Now that you have your PYF strategy rolling the next question that pops up is what do you do with it. My go to is paying off debt, but even before that I think just about anyone in the personal finance industry would say save at least $2,000 an an emergency fund.
I was recently asked about the best place to keep an emergency fund – Ally Bank. It is where we keep our 4 month emergency fund (we want to increase it to 8-12 months soon) because they offer 1.2% interest on it and it takes 3 days to access.
The 3 days thing is actually a pro in my mind – I don’t want to be able to slide money to my checking when I am over budget with ease. Remember, it is an emergency fund not a, “I really need this new jacket fund.”
Once you have your emergency fund, I would tackle debt, save a bigger emergency fund, then it gets fun. Hypothetical, you have no auto debt, no student loan debt, your emergency fund is 12 months deep and you have been paying yourself first for some time, where do you go next?
Well, I wrote a super underrated post here about using extra income and a HELOC to accelerate a mortgage if you own, you can read that here. How awesome would being mortgage free be?
If you don’t own maybe you save up for a 20-40% down payment. Or if you would rather invest/save then that is the next step for you. No matter what, you have options and control.
That is the entire point of the pay yourself first strategy. You are taking care of yourself first before you spend.