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Rent, groceries, gym memberships, home maintenance, streaming subscriptions — your list of monthly expenses can seem endless. So it’s no wonder that by the end of the month, you might not have much left to put into a savings account.
If that situation sounds familiar, there’s a savings strategy that can help. It’s called “pay yourself first.”
What does it mean to pay yourself first, and how do you do it? Read on to learn more.
What does it mean to pay yourself first?
“Pay yourself first” is a strategy that emphasizes prioritizing savings and investments before spending on other expenses. The idea is to allocate a portion of your income to savings, retirement accounts, or investments as soon as you receive your paycheck, rather than saving whatever is left at the end of the month.
This method is sometimes called “reverse budgeting” because it prioritizes savings over expenses and discretionary spending.
By treating your savings as a fixed expense, you build consistent savings over time, eventually allowing you to achieve long-term financial goals, such as buying a home or retiring with enough to live comfortably.
Why paying yourself first is important
Paying yourself first is an important financial exercise. It ensures that your savings grow consistently over time and that you’re making progress toward your goals.
Additionally, getting in the habit of paying yourself first helps build financial discipline. It prevents overspending and encourages more responsible spending and budgeting.
Plus, by paying yourself first, you build a financial safety net in case an unplanned expense or emergency financial situation arises. Having cash in the bank at the start of each month means you’re less likely to rely on credit cards or other forms of debt to get by.
Read more: How much can I save in a year with $10,000 in a savings account?
How to pay yourself first
Paying yourself first is not always easy, but it is entirely possible with the right approach. Here’s how you can ensure you always pay yourself first.
1. Set a savings goal
Decide a percentage of your pay you want to use to pay yourself first. A common recommendation is to save 20% of your pre-tax income, with 15% for retirement and 5% for short-term savings.
You can always adjust the percentages if your finances don’t allow you to save 20%. For instance, you could save 12% for retirement and 4% for short-term savings. In other words, you can keep the ratios roughly the same but lower the total percentage. Ultimately, the goal should be achievable.
Read more: How much of your paycheck should you save?
2. Decide where to put your savings
As you contribute to your savings, it’s important to put those funds in an account that generates compound returns with few, if any, costs. This will allow you to hedge against inflation, preserving the value of your dollars and helping your balance grow exponentially over time.
Savings accounts are ideal for this purpose since they’re designed for holding funds long-term, not spending.
In particular, high-yield savings accounts are a great place to keep your short-term savings because they pay higher-than-average interest rates. In fact, some of the best high-yield savings accounts pay 5% APY or more.
However, for longer-term savings goals, such as retirement or college, a tax-advantaged investment account is a better choice.
If you’re not sure about the right account for your savings or the ideal strategy for reaching your savings goals, it can help to speak with a financial adviser for some guidance.
3. Set up a budget
The key to paying yourself first is making savings a line item in your budget. This allows you to adjust your budget around the money that remains after you’ve set aside your savings.
If you find that your total expenses exceed the amount of income you have left after saving, you may need to tinker with your budget categories and potentially cut down on discretionary spending in certain areas.
Read more: How to budget: Your complete guide to budgeting for 2024
4. Enable automatic transfers
Another step you can take to ensure saving money remains a top priority is automating your contributions.
Many banks allow you to set up automatic transfers to and from deposit and investment accounts. In many cases, you may also be able to have your employer deduct a portion of your paycheck and deposit it directly to a 401(k) or other retirement account.
Of course, this works best if you get paid the same amount at regular intervals. You may need to transfer money manually if your pay is less consistent.
Read more: Should you automate your savings? Pros and cons to consider first.
5. Make adjustments as needed
It may be necessary to make adjustments to your plan for various reasons.
At first, you might have to adjust your contributions if they don’t quite fit your finances or budget. Eventually, you might need further adjustments due to changing life circumstances, such as getting married, a change in your salary, or relocating.
If your expenses increase, it may be necessary to reduce your savings. Or if your pay increases, perhaps you can pay yourself more. Revisit your budget at least annually to ensure it still works for your finances.
