Reverse Budgeting: How to Pay Yourself First

I remember reading David Bach's book for the first time.

Bach's book, The Automatic Millionaire, originally published during my senior year of high school in 2005, but I didn't read it until some years later. But the minute I cracked light blue book, these six simple words 100% changed my finances forever:

You need to pay yourself first.

If I am being 100% transparent, I had no clue what it meant to actually pay yourself first, let alone the steps to make it happen.

Perhaps you were like me five years ago, the person who constantly found themselves scraping the bottom of the barrel for a few dollars just to get a few groceries because I blew my bi-weekly paycheck on everything already.

Even with a somewhat decent career and income, I was always a bit perplexed as to where all my money was going each month. But then it hit me… I just

In other words, it's time to learn how to reverse budget and pay yourself first.

What You Will Learn: Learn what it means to pay yourself first, how to cut back on high spending areas, and save more for your future using the pay yourself first method. In my opinion, this is the most practical and perhaps the best personal finance advice you can apply, even with a simple understanding!

Why do you need to pay yourself first?

Real quick, answer these five questions in your head:

  1. Do you feel like you have enough money at the end of each month?
  2. Do you make a good amount of money and sometimes seem confused as to where it goes?
  3. Do you have 3-6 months in an emergency fund?
  4. Is at least 15% of your income going to retirement, savings, or being used to pay off debt?
  5. Can you honestly say you feel great about your progress towards your financial goals?
  6. Do you love tracking your expenses?

If you answered yes to all 5, you're in a good position when it comes to managing your finances and whatever you're doing – keep doing it! However, on the other side of the coin – if you said “No” to one or more you might want to implement the pay yourself first strategy as soon as possible.

In the article “5 Rules to Stop Making Money Complicated” one of the simple money rules that is recommended is to dumb down money.

Understanding financial concepts and how money works isn't very hard, you just have to make your sure have a plan and create awareness around your finances.

The simplest way to do that? Use the steps below to pay yourself first!

How to Pay Yourself First!

First, let's start with the essential premise behind paying yourself first:

As Bach says, you should always pay your future (yourself) before you pay bills and spend your money. This graphic actually explains the pay yourself first strategy in five simple steps:

How to pay yourself first graphic

5 Steps to Pay Yourself First:

Sometimes referred to as “Reverse Budgeting,” the action steps to start paying yourself first are extremely simple to implement.

Here is how it all works in a nutshell:

Step 1: Add Up Your Income

Figure out your monthly net income (what you bring home each month). This is not your gross salary, this is the amount of money you see in your bank account every two weeks.

Be sure you use conservative estimates if you don't get a regular salary. For example, if you get paid in sales commission, take your average month, not your highest!

Use this Google Budget Template to record your income.

Step 2: Add Up Fixed Expenses

Figure out how much your fixed expenses are each month. Fixed expenses refer to your reoccuring bills such as:

  • Housing
  • Utilities
  • Insurance
  • Fuel
  • Daycare
  • Cell phone, etc.
  • (Use this list for more fixed expenses)

Step 3: Subtract Your Fixed Expenses

Subtract your fixed expense total from your monthly income. The left over amount is what you will use to determine how much to save (for yourself) and how much to spend.

For example:

  • Monthly Take-Home Income: $4,000
  • Monthly Fixed Expenses: $2,500
  • Result: $1,500 left over

Step 4: Pay Yourself First

Determine how much of your leftover income you will contribute towards paying yourself first!

Paying yourself first can include using your money to:

  • Increase your emergency savings,
  • Paying off bad debt like consumer debt or student loans
  • Investing in your retirement accounts such as 401K or IRA
  • Placing money in brokerage accounts and investing in stocks

For example, from the scenario in step 3, of the $1,500 left over each month, perhaps you decide to pay yourself first with $800, then use the remaining $700 for spending!

>> See also: Increase What You Keep; Your Real Hourly Wage

Step 5: Spend Last!

By figuring out a number monthly to pay yourself with – the money you will now use towards debt, savings, or investments – you are able to avoid the temptation to overspend.

Perhaps the best thing about the pay yourself first strategy is you are able to remove the budget killer, also known as our human behavior!

Knowing how much you're going to spend before you spend it is one thing, but knowing you already paid yourself first and set aside money for bills is another.

Here is how the concept of paying yourself first before spending would look like for the median American household:

Real Life Pay Yourself First Example:

Using 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 dual-income couple with no kids:

Monthly Net Income$6,500
Fixed Expenses $4,000
Leftover:$2,500

In this scenario, this hypothetical couple would have $2,500 each month leftover to pay themselves first, then spend.

Most financial experts still recommend saving at least 20% of your income, therefore in this scenario, this couple would want to pay themselves $1,300 per month.

Always erring on the conservative side, this still leaves them with $1,200 for spending with the option to save even more. The same couple who may have felt they never had any leftover money all of a sudden is saving 20% of their income and still has $300 a week for spending!

But how would this couple (or you) practically apply the pay yourself strategy and make it work?

6 Practical Ways to Pay Yourself First:

The simple way to pay yourself first goes back to the intro in this article – or as author David Bach says, automate it!

Simply take the amount you plan on saving and automate it so that the minute you get paid – you pay yourself first.

For example, the same couple from the scenario above who is paying themselves $1,300 per month can apply the PYF strategy a few ways:

  1. First, they would divide $1,300 by the number of checks this couple gets each month: $1,300 / 4 = save $325 per check. Options after include:
  2. Set up direct deposit for $325 to go straight to savings
  3. Enroll in employee match 401K programs and earmark $325 for retirement savings
  4. Manually make extra debt payments with the $325
  5. Set up automatic reoccurring savings transfers

The most efficient way to pay yourself first is to use the crock-pot approach – set it and forget it.

By automating your savings, debt payments, or investments, you will quickly adjust to some small lifestyle adjustments you might have to make, and soon forget you're even saving.

Before you know it, you are saving 20% of your income and it doesn't even feel like it!

1. Create an Emergency Savings:

With a working-class population of 80% who live paycheck to paycheck and more than 50% who don’t have $1,000 to their name, the first step in paying yourself might be to first create an emergency fund.

Online banking has made saving easier than ever, simply:

  1. Login to your online banking or create a saving account with Ally.com
  2. Set up a “Reoccurring Transfers” using your pay yourself first number
  3. Automate it so that a portion of your check goes to savings every time you get paid

*Note I used Ally because they are about as high interest savings as you can get these days and I like having separate checking and savings*

2. Live Off One Income (Couples):

For my wife and I, we personally have used the pay yourself first strategy for over 4 years to help us pay off over $200,000 in student loans.

How did we do it?

We lived off my income and took all of her checks and made extra student loan payments. The minute she got paid every two weeks we took 100% of her check and manually paid a specific student loan principal.

3. Divide By 2 or 4:

Once you know how much you're going to pay yourself first with (20% or more is ideal) simply take that amount and divide it by the number of checks you get each month!

  • Single = Pay Yourself Amount/2 checks
  • Couple = Pay Yourselves Amount/4 checks

The result? That is how much you should pay yourself first with every time you get paid!

4. Manually Pay Off Bad Debt:

Credit card debt, high interest loans, and even student loans are all forms of bad debt.

You can't pay yourself first (as much) if you're constantly shelling out $100's in interest charges each month. So while the next two recommend investing, if you have bad debt pay that off first.

  1. Use your pre-determined amount from each paycheck
  2. Manually make PRINCIPAL payments towards one bad debt at a time
  3. Use either a debt snowball or avalanche strategy

5. Pre-tax Investment:

When I was 22 I met with the work sponsored retirement planner and he taught me about a 403B (similar to a 401k).

From that day on I start contributing to my retirement with a set amount from each check. I went with a post-tax contribution, however, my wife took advantage of her pre-tax 401k match at her work.

Besides free money, her pre-tax investment and even my post-tax investment are done before we ever see our checks. Therefore – it's the ultimate form of paying ourselves first!

6. Use Your Annual Raise:

In 2018, after paying ourselves first for over two years and getting used to our spending budget, we decided we would roll any raise to our retirement contributions.

Consider every time you get a pay raise taking that amount and automatically paying yourself first!

Whether you decide to use your raise for emergency savings, general savings, debt or retirement – the choice is yours – just remember to pay yourself first!

Wealth – The Advantage of Paying Yourself First:

Need to pay off debt?

Need to save for the future?

Need to invest more into retirement?

All of these can be done in a multitude of ways, but it starts with recognizing that paying yourself first is more important than spending.

In the end, paying yourself first means you take care of your FUTURE first and that is how you build wealth. It is nothing more than a way to save more and spend less!

Debt, investments, savings, emergency savings, roth IRA, stock index funds, 401k's, spending funds – you name it – are all forms of paying yourself first!

However, they all start with having enough money in the first place to save or get out of debt!

And when you really dumb it down, they are all simple to accomplish when you subtract the element of human behavior. The pay yourself first strategy will promote accountability to yourself, which is why it might be the best personal finance strategy out there.

By paying yourself first, you in a sense, remove the possibility of temptation or impulse spending. The approach requires some discipline, but with correct budgeting and automation, the idea is almost seamless.

The advantage of paying yourself first is the idea of security. Security for your future. Securing your future by figuring out what percentage of your income you can allocate to your future can help you avoid financial stress, thrive during economic downturns, and build wealth for your future!

Question: Do you use the pay yourself first strategy?