The Most Important Strategy to Help You Build Wealth – that hardly anyone does!
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It seems that the number one complaint with families who are trying to get ahead financially is that there is never enough money at the end of the month to save. Hands down! That’s the reason! Yet, little did they know that they were already doomed by payday. With one small tweak, they could have nailed it and saved hundreds that month. It’s a straightforward concept that many choose to disbelieve or just overlook. It’s to pay yourself first! Let’s dive in and see how YOU can save hundreds this next month!
Is a Pay Yourself First Strategy even needed?
According to Investopedia “Research on savings indicates that a relatively small percentage of Americans follow the “pay yourself first” adage. As of 2016, fewer than a quarter of Americans had enough savings to cover six months’ worth of expenses, and as of 2017, an estimated 39% of Americans had no savings at all, and 57% had less than $1,000 in an emergency fund. In 2018, 23% of Americans had nothing saved for an emergency.” (source)
So the answer is YES!
How People & Families Currently Save Money
A typical American household will go about their month by paying their bills first and then use what’s leftover to “save”. But, we all know what happens in this scenario. (I know this because I used to budget this way too, and no, it never worked for me).
So you pay your bills, you intend to save the rest but what happens is that you almost always find something that you “need” to buy. And why not? You checked your bank balance, and you still have cash in there! And swipe, there it goes. Two days later, you remember that the money was for “saving”. ARG!
With Paying yourself first, there is no ARG moment, because you took care of your family first! Could you imagine if the IRS waited until the end of the month to collect from people? Taking their portion first was probably one of the smartest things the government has ever done! (belly chuckle)
If you are interested in reading more in-depth about the Pay Yourself First model the dive deep into David Bach’s book The Automatic Millionaire, where he covers this and other critical financial lessons. Although I do disagree with his thought process that you don’t really need to budget, I find that the other 97% of his teachings are gospel! All of his books are a great read, but this is a perfect starting book for newbies to Bach’s framework on personal finance.
Can paying yourself first really work? YES! You need to do this for yourself! You need to stop putting other people’s priorities before you & your family’s goals. Please read and know that…
How to Actually Pay Yourself First and Save Money like a Pro
- Step One: decide how much money to save
- Step Two: determine where you want it to go
- Step Three: make it an automatic transfer
- Step Four: repeat as needed
For my family’s set up, we pay ourselves first four times before we pay any bills! Sounds odd but let me explain. My husband I both have workplace retirement buckets, I have an IRA, and we have multiple sinking funds. All of these accounts are for “saving”. Let’s drill down into the steps below.
Step One: Decide How Much to Save
A good rule of thumb is to start at looking to save 7-10% of your gross income. You can, and should, increase it later on to 15%, maybe even 20%. Ideally, 15% goes straight into retirement accounts, and the other “savings” goes to sinking funds for planned purchases.
Step Two: Decide Where You Want the Money to Go
Figure out where you want this money to go. Investments? Emergency Fund? Let’s start with an option that probably will give you FREE MONEY. Because let’s face it, money doesn’t usually grow on trees, but in this case, it does! It’s called a 401(k) money tree (no, not really).
Saving Money in Workplace Retirement Programs:
Many businesses offer a workplace match program, and this is the free money part. Where, when you put in a certain %, then they match you a certain %. These can vary wildly from no match, up to 15% depending on the industry and company. Some even split it, as with my regular day job, they put in $.50 for every $1 that I put in up to 5%. So in very basic and rough math a 2.5% match, not great. BUT, free money is free money, I’ll take it!
If you work for the government, schools, or nonprofits, you will have a similar program but with a different title. I.e., a 403(b), a 457 plan, pension, etc.).
This money is taken out of your paycheck for you (the ultimate in paying yourself first methodology); you don’t need to transfer anything, see your HR Dept for paperwork. However, you will need to decide a few key things; if you want pre-tax (traditional) or post-tax (Roth) paycheck deductions. This is a deep rabbit hole, which I won’t go into right now, as we don’t have 548 hours to debate the merits and drawbacks of each.
If you are just starting out with saving money, then contribute just enough to get the employer match, and then let’s shift to the next most essential savings bucket, your emergency fund.
Saving Money in an Emergency Fund:
If you have zero in savings, then let’s get you going! An emergency fund is a cornerstone in having a secure financial framework. Without it, if something terrible happens, you will end up with mounds of credit card debt that could spiral downward in no time flat. You may even be already in that spot. Breathe deep; it’s okay, you’ve got this! Let’s get to planning!
You should have an emergency fund of at least six months of living expenses set aside for real emergencies (i.e., lost a job, lost your house or your car, hospitalization, etc.). Some people feel more comfortable with a nine-month cushion, and that’s fine too, I just wouldn’t go lower than six months cushion.
Step Three: Make it Automatic
Set up an automatic transfer for three days after payday. (sometimes weekends or holidays cause deposits to be in “pending” status, so you don’t want to overdraw. Three days is safe for everything to clear into your account before you take it out.
Automating your savings is crucial to making them happen. Trust me; life will get in the way, you will forget, or find another use for the money. Please trust me on this, it will be so much easier for you to automate it, and it will be 100% consistent.
For our setup, we get paid (workplace contributions are automatically taken out of our paychecks), and then three days later we have auto transfers set up into my IRA and our daughter’s ABLE account, and all of our sinking funds. I never have to do anything!
Where to Put Your Emergency Fund
You can’t pay yourself first into your same bank account, too confusing, so you should look into having more than just the regular one checking and one savings account. You need to separate your money, so there is never any confusion about what funds are slated for what purpose. No debate! It must be separate!
My bank allows us to have multiple accounts without fees. Please check with your bank on any qualifiers that you need to meet to have multiple free checking accounts.
If you have the habit of all too easily transferring money back and forth into accounts, consider opening an account at a separate establishment. That way, you don’t see it on your regular banking interface. For example; my family’s Emergency Fund is in a savings account at Ally Bank, I never actually see this money on banking screens, it’s entirely separate.
One of the great things about having an Ally bank savings account for our Emergency Fund is that it earns a MUCH HIGHER interest there than it would at our regular bank. Every day banks typically offer horrible interest rates on savings accounts, like .08% APY, while some even go as low as .01%. While Ally is now offering 2.2% (as of March 2018, yet this could vary slightly at any time).
For example – if you had a $30,000 emergency fund. In one year at a
regular bank with a savings account of .08% APY you’d earn $24. While at Ally, with 2.20% you’d earn $660. Then that money starts earning interest too, so you’ll automatically pay yourself first agian, and again!
Ally bank is so consistent with their rates, service, and features that Money Magazine rated them the Best Online Bank of 2018 (source) Oh, and $0 service fees on both checking and savings accounts.
So there’s my emergency fund, making me money, and I’ve basically forgotten about it. This is definitely a good feeling!
A Common Mistake and How to Sidestep it
You must also change the name of your account to “EMERGENCY”, yes all caps, because the psychology around this is legit! Giving a specific name to your funds makes it A LOT harder to “borrow” money from it for a non-emergency related purchase. Trust me.
You can now look at your bank account balance (after your payday and monthly automatic transfers) and know that what is in there is money that you can spend on whatever you need. You don’t have to worry that you won’t have anything left to save.
I know your account balance will look lower than it usually does, but don’t freak out. This is all part of the new plan, and as I said before, anything new takes a bit of getting used to.
Let’s recap where we’re at…
- contribute just enough in your workplace retirement plan to get the full match.
- add to your emergency fund, having no less than six months living expenses.
BUT WAIT, what about debt repayment? Where does that fit into the plan? Undeniably the King of Getting Out of Debt is Dave Ramsey. His methods have worked for thousands, maybe even hundreds of thousands of people. He has many solid teachings. Yet, I don’t 100% agree with all of his advice.
For now, let’s look at his first four Baby Steps to be taken in this exact order…
- Save $1,000 emergency fund
- Throw ALL your money at debt repayment and be 100% debt free besides your mortgage
- Go back and finish emergency fund with 3-6 months expenses
- Invest 15% into retirement buckets
You can see we part ways at step one, whoops! I’d never turn down free money, and neither should you! Remember, you should take everything with a grain of salt, some moderation, and some flexibility. I am fine on agreeing to disagree with him on this 🙂
If you are interested in learning more about his teachings (they were the first personal finance books that I read) then check them out. If you need some convincing on his program and like case studies, then check out The Total Money Makeover: A Proven Plan for Financial Fitness. Or if you want to cut the fluff and get straight to the actionable steps, then Dave Ramsey’s Complete Guide to Money is for you. Happy reading!
Step Four: Repeat as Needed
If you still have funds available then go back and look at contributing more to your workplace plan (if they have good options) or look at opening an IRA account. Which is very similar to the 401(k) plan but it’s your own. It’s an Individual Retirement Arrangement. This can be a better option because you can choose your investment firm and how you want to invest your money. I.e., pre-tax, Roth, ETF’s mutual funds, bonds, INDEX funds, etc. This is again a HUGE rabbit hole that we won’t go down today. If you still have some funds left to save then maybe look into sinking funds. For now, just in the habit of paying yourself first.
RELATED: Do you have your emergency fund and retirement contributions set and steady? Then let’s start looking at sinking funds!
Ready to implement the pay yourself first model with your business? Check out Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine, which the author Mike Michalowicz lays out an amazing step by step framework for regular business owners to always make sure that they too always get paid!
At the End of the Day
This method has enabled my family to build a full six-month emergency fund, and have four separate sinking funds (house, car, vacation, kiddo). We’ve been able to plan ahead, so any purchases in those categories are essentially already paid for. It’s so nice to be able not to worry when your car goes into the mechanic shop, as you know you have it covered!
Paying Yourself First can seem like a drastic change to saving money, but think about it, the currently “normal” way of saving money hasn’t really worked (see paragraph two on the sad state of American’s savings). So it’s time for something new, something different because you will never reach your dreams if you don’t prioritize them!
It’s time to put you and your family’s future and goals first!
Let me know in the comments below, what percent of your pay are you saving? Remember, it’s totally okay to start small so long as you just START NOW!
- The Automatic Millionaire by David Bach
- Ally Bank
- The Total Money Makeover: A Proven Plan for Financial Fitness by Dave Ramsey
- Dave Ramsey’s Complete Guide to Money
- Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine by Mike Michalowicz
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