December 13, 2018

Quick Answer #2 – What does pay yourself first mean?

qa-2-imageQuick Answer

Pay yourself first (PYF) means to redirect a portion of the income you receive to retirement savings, emergency savings, or some other type of savings as soon as you receive it, and before you pay any other bills. In other words, the first bill you pay each month should be to yourself.

This is likely the most important habit you should adopt to help you reach your goals, obtain peace of mind over your money, and provide choices to you and your family. Think of it as The Golden Rule of Personal Finance.

General Rules

  • The more you automate the process to move money directly into your various savings accounts from your paycheck the better. Out of sight and out of mind works.
  • For retirement savings, commit to saving at least 10% of your gross income and ideally, strive for 15% – 20% during your peak earnings years.
  • You can break emergency savings into two levels and build these up over time (these are in addition to your retirement savings).
  • Level One emergency savings are for unexpected things such as your car breaking down or your air conditioning going out. Strive to have at least 10% of gross income in your Level One emergency savings account.
  • Level Two emergency savings are for life changing events such as the loss of a job or a major health issue. Strive to have at least 20% of gross income in your Level Two emergency savings account.
  • If you keep all funds in one account, you will be more tempted to use the money for something else because you are more likely to view it as one big pile of money with no specific purpose.
  • Having separate accounts for each type of savings is a mental trick to help reinforce the purpose of the funds. For example, the more you view your Level One emergency savings account as money to pay unexpected bills, the less you are likely to use the funds to go out to dinner.
  • It is okay to start with smaller amounts and build up to the recommended levels. For example, if you feel you cannot save 10% of your gross income towards retirement today, then start with 5% or whatever works for you – the key is to get started.
  • It is important to get started on the habit of paying yourself first sooner rather than later because this habit sets the foundation for everything else in your financial life.

Benefits

  • Paying yourself first means the money comes out of your income as soon as you receive it so it is no longer available to be used for other things.
  • There is no waiting until the end of the month to see what is leftover to put towards savings, which does not work, because there will never be anything left over – you will always find a reason to spend your money on something.
  • It is psychologically rewarding to know each time you receive income, that you have immediately done something with it to help secure your future.
  • The rest of the money you have left over after paying yourself first and paying all of your other bills, can be used as you see fit without guilt or worry because you know you have taken care of the important things.

Where to Find Additional Information