The Importance of Paying Yourself First

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Updated on Tuesday, July 22, 2014

Male hand putting coin into a piggy bank

Payday: one of the best days of the month. It’s a day to pay the bills, throw money towards any debt and likely splurge on a recent purchase you’ve been eyeing. But before you put money towards your bills or hit purchase on your recent Amazon buy, consider a classic piece of personal finance advice: pay yourself first.

No matter which personal finance expert you look up to, they all have one unified message: save your money.

We aren’t ones to argue with the entire personal finance community, except we prefer you look at saving in a unique way. Instead of just tucking away the money leftover at the end of the month, you need to make saving a priority. It should be the first thing that happens with your paycheck. Here’s how:

Step One: Run the numbers

We can sense you want to argue, “I don’t have any money to save.”

Before you reach for that tired excuse, we want you to run the numbers.

Sit down and write list of your monthly expenses. Consider costs like your cell phone, rent, utilities, tuition (or student loans), any debt payments, groceries, and your “fun fund” for eating out, going to the movies or bar hopping.

After adding up your expenses, subtract your expenses from your monthly income.

Our hypothetical college student Lizzy earns $1000 a month and her expenses total to around $850 a month.

She only has wiggle room of $150 after each paycheck.

Step Two: Set a percentage

Using Lizzy as an example, she could save 15 percent of each paycheck and still have enough money left for expenses.

Except that some months are more expensive than others, so she may need some of that remaining $150 (even though she has fun activities built into her budget).

Lizzy is comfortable with contributing seven percent ($70) of her monthly income to her savings account.

This may sound like a small number, but if Lizzy diligently saves $70 a month, she’ll have $840 tucked away by the end of the year. If she continued with this practice through four years of college, she’d have $3,360 from just contributing a small amount of each paycheck (not including interest). She might even get a raise during the four years of college and be able to contribute and save more!

Step Three: Set up a savings account

Once you’ve set your percentage, you need a place to stash your cash. Your checking account doesn’t provide much of a safe haven because you may be tempted to spend the money earmarked for your nest egg. Plus, checking accounts won’t help you earn money in interest (unless you count a penny a year big bucks).

Setting up a savings account is simple. You can look into doing one with your current bank, but we recommend using an Internet-only bank. If you’re already using an Internet-only bank, color us impressed.

Internet-only banks offer higher interest rates on savings accounts than traditional brick-and-mortar banks because they save immense costs by eliminating the local bank branch. They’re FDIC insured and just safe as using your local bank.

For example, Ally has no minimum deposit to open a savings account and offers an interest rate of 0.80%. That may not sound like much, but Bank of America requires a $25 minimum to open an account and only offers 0.01% APY (annual percentage yield).

A savings account will give you a location to allow your money to earn a higher interest rate than a checking account. Plus, it’s gratifying to watch your fund grow and know exactly how much you have saved.

Step Four: Pay yourself first

Once you settle on a percentage, even if it’s .05%, start to diligently save each time you get a paycheck. Before you pay off bills or go on a spending spree, you need to put that money into savings.

Even if you can only afford $1.50 each month, you need to start getting into the habit now. The younger you begin saving, the happy your older self will be.

Don’t roll your eyes and say, “Ha, $1.50 a month. That can’t even buy me a latte. Why would I bother putting that in a savings account?”

In the beginning, it isn’t about amassing a fortune in your savings account today. This is about building a foundation for your financial future. It’s a practical way to start saving instead of randomly throwing money into a savings account when you occasionally have leftovers.

Step Five: Adjust your percentage as your budget and income change

Hypothetical Lizzy earned $1,000 a month in college and could only save $70. Once she graduates, Lizzy lands a job earning $2,500 a month, after taxes. She needs to run a new budget to account for any increases in expenses.

If Lizzy sticks with her commitment to pay herself first with seven percent of each paycheck, she’ll be increasing her savings from $70 to $175. A simple habit developed in college will result in her saving $2,100 a year (before interest).

If Lizzy runs her numbers and determines she can save more, let’s say 15 percent, she can be saving $375 a month or $4500 a year (before interest).

It’s up to you

Like any habit that’s good for you (exercise, eating the right foods, not binge watching Netflix every night), it can take time to be dedicated to saving a portion of each paycheck.

It’s okay to screw up, but the sooner you start forming the habit, the faster you can accumulate wealth.

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