I’m five years old and gifted my second piggy bank. This one is not actually a piggy. The clear, house-shaped plastic box has stickers adhered to the front that resemble storefronts. One 2D marquee reads Spend, another Share, and the final Save. The non-traditional piggy bank was meant to teach me to think beyond the candies and crayons in the checkout aisle, and consider whether I might eventually want to purchase that cat sweatshirt I saw at Target or contribute money to my schools annual Lenten coin collection to feed starving children across the globe.
As I learned to write, count, and play nicely with others, my parents were working subtly to instill my curious mind with good financial habits. I practiced with pennies, so that I could later apply the same principal to an income a bit more substantial than coins found under the schoolyard jungle gym. Whenever I received birthday money or found a parking lot penny, my parents watched from a distance as I decided how I would allocate my new-found wealth. Nearly every time, I split it evenly three ways.
Long before holding my first job or embarking out into the real world, my mother gave me the most important financial advice I would ever receive. When she began one of her first jobs, my mother’s coworker advised her that with each raise she should put the difference towards savings or retirement and continue to live on the entry-level position wage. By doing so, my mom was able to purchase a town home and save for retirement while attending college. Later, she would go on to became self-employed and devour dozens of business books. By the time I was ten, the concept I had heard throughout my life had a catchphrase: Pay yourself first.
At ten years old, I thought that pay yourself first meant to put money in the Spend slot rather than Share. It didn’t make much sense without the knowledge of Roth IRAs, 401ks, other investment vehicles, and high-yield savings accounts. That understanding would come with time.
What does it mean to pay yourself first?
Paying yourself first means that you are making regular contributions to your savings before taking care of bills and other expenses. Money is redirected toward emergency savings, retirement accounts, or long-term savings goals before buying groceries, making your car payment, going out to eat, or paying off your student loans. Rather spending based on your total paycheck, you budget based on your total paycheck minus the amount you are allocating to retirement and savings. You’re not waiting until the end of the month to save what’s leftover. You save first, every month.
You can pay yourself first by signing up for your company’s retirement plan, setting up automatic deposits, routing a portion of your paycheck to savings, or manually moving the money around. The goal is to put money in savings each month before you do anything else with your money. This concept is sometimes called reverse budgeting because you plan your spending around your savings goals, rather than saving whatever you have left after a month of spending. It is a simple strategy that prioritizes the needs, wants, and well being of your future self, and helps to establish a consistent savings routine. With time and the accumulation of wealth, your can see the fruits of your effort as your savings accounts pay out interest and the value of your stock portfolio continues to grow.
Work for your money, and then make your money work for you
I’m now in my early-30s and my mother-in-law often quibbles about how her son is living like a pauper. It may be true that we don’t own a television, go on exotic vacations, or tout our political beliefs around on short-lived merchandise, but I would argue that we don’t quite meet the definition of “one who is extremely poor.” In fact, I would argue that the reason that we have achieved a reasonable net worth is because, as Dave Ramsey would say, “If you live like no one else, later you can live like no one else.”
I made it a priority to set up an emergency fund prior to signing my first apartment lease, just in case there were an unexpected expenses. In the ten years since that first lease, my emergency savings slowly has grown to over $20,0000–rising and dipping based on unexpected expenses–because I’ve made a commitment to pay myself first and developed the habit.
I opened up a Roth IRA account shortly after I began working and set up automatic withdraws, starting at $50 per month when I was making minimum wage and now $500 per month to meet the maximum annual contribution limit of $6,000. I have invested 12% of my income to a 401k for the last six years, the last two of which have been matched at 2%. This comes out to approximately $6,000 annually, bringing the total annual retirement contributions to $12,000. This 30-something pauper is setting herself up for a comfortable retirement!
Did you ever learn about the power of compounding interest in school or at home? Compound interest is the addition of interest to the principal sum of a deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest. Thanks to consistent investments over the last decade, my money is now working for me. In just the last three years (and after eight years of consistent saving), $35,000 of my balance change has been reinvested dividends that I earned simply by delaying gratification! A decade-worth of hand-me-down furniture, thrifted clothing, and low-cost social interactions–while passing on the new car, trendy clothes, and nightly takeout–gave me the opportunity to watch my money grow. Which it has, by nearly 12% since my initial investment in 2012.
By the time I retire in 30-odd years, I imagine a large percentage of my portfolio value will reflect those decades of interest earning interest. And it’s never too late to start. Whether you are in your early-twenties or in your late-fifties, saving for your future is always a good idea, and the tiniest first step today can help foster a lifelong habit.
The benefits of paying yourself first
In my decade or so of work, I’ve consistently exercised the practice of paying myself first, to the extent that it has become a solid habit. Putting money in savings before you do anything else ensures that you are saving money each month, even if an unexpected car repair or medical bill crop up. The money you already have saved will help cover this expenses, and save you the stress of trying to figure out where the money will come from. In 2015, my car died unexpectedly and my savings provided a hefty down payment to minimize the interest rate on my car loan. In 2017 and 2018, I incurred tens of thousands in medical bills and was able to pay everything off with emergency savings. It can be hard to start saving for some abstract future catastrophe, but after the first time you need the savings, you will do everything you can to keep it.
On the other side of the same coin is saving for future desires, both defined and unknown. By paying yourself first, you are setting aside funds for a down payment on a home, a new car when your stops running, or even a wish-listed All Clad pan or backpacking sleeping bag found deeply discounted. If you have several thousands in savings, is easier to pull the trigger on an expensive purchase that will be hard to find cheaper or last far longer than the lower-priced options.
By paying yourself first, you are prioritizing your future self and your financial destiny. There is something empowering about saving for retirement many decades before the event enters your radar. By saving consistently, you set up for a comfortable and secure life in your later years, without the worry of burdening your family or struggling to pay medical bills. Each time you say no to the name-brand latte, pack your lunch rather than eat out, or pass on the clearance shirt that you don’t love and probably won’t wear, that is money that can be reallocated to more meaningful purchases that align more clearly with your values. You likely will not remember the discarded shirt, but you will remember your first vacation aboard and the pride of saving enough money to finally purchase a home.
Another benefit of paying yourself first is that you will be better prepared for emergencies. Several years ago, I was in a job that made me miserable, so one day I committed to saving aggressively until I had enough saved to cover six months of expenses. This gave me the freedom to walk out at any time and, until then, a goal the required me to keep showing up. Whether you end up in a bad relationship, a toxic living situation, or a terrible job, a emergency fund gives to the freedom and security to pursue something new without worrying about money. In the last seven years, we have had to replace every one of our thirty-year-old appliances, as well as the A/C unit and water heater. It hurt our wallet, but not as much as if we had not had the the savings in waiting. Whatever is broken in your life, money can act as a salve to ease some of the challenges and help you navigate toward a better situation.
Having funds readily available also means that you can take advantage of pay-up-front service discounts and bulk pricing, as well as buying en mass when something you use regularly is on sale for a great price. These funds allow for the purchase of that limited-time-offer to fly across the globe for $150, the acquisition of that $400 coat you fell in love with at Filson Seattle that is now 70% and comes with a lifetime warranty, and $400 worth of cod liver oil because it is on sale and it’s never on sale.
But what about debt?
I am lucky to have graduated college with only a few thousand dollars of debt, which I paid off aggressively within two years. As I paid off my loans, I simultaneously contributed to savings and retirement. During that time, the savings contribution was minimal, but I still understood how important it was to build that habit. Thanks to my parents’ guidance, I knew better than to take on consumer debt that I couldn’t pay off monthly or to take out an unreasonable car loan with an outrageous interest rate.
But, a lot of people do have debt. Education is expensive and it can be difficult to save when you are just getting start or encounter a huge setback in life. If you fall into this category, a good place to start is to build a small emergency fund of $500-$1,000 and then defer the majority of your money towards paying off you credit card debt, especially anything with a high-interest rate. As you pay off debt, allocate $10-$25 per month to savings to keep up with the habit and give you tangible evidence of your efforts and helps protect you from future debt.
How much money should you pay yourself first?
This question will vary from person to person and change across different stages of life. In my early-twenties, I could afford to save about $100 per month. At that time, that was a slightly challenging but doable amount. It meant that I could meet a friend for tea but a not a meal, or that I would visit the library rather than the bookstore. The reality is that you need to think about your personal financial goals and from there.
The standard financial advice is to save 20% of your income. That means that if you make $60,000 annually, you should be saving $1,000 per month. For some people, that number may sound astronomically high. For others who want to retire early or have other big saving goal, that number might not be high enough. The annual IRA contribution limit is $6,000 for 2020, which breaks down to $500 per month. That is a great goal to begin with.
After you have decided how much money you will pay yourself first, create a budget around that goal. Consider the high-priority bills–mortgage, utilities, groceries, etc.–and then add in the discretionary spending–clothing, entertainment, travel, etc. You may need to take a close look at where your money goes each month and then rethink your spending habits. While putting aside an extra $10, $100, or ever $1,000 may seem trivial as you’re getting started, that money will grow with time. I can almost assure you that you won’t look at your bank account and retirement balance ten years from now and wish you would have spent that money one lattes, avocado toast, and all those other frivolous things that it’s all too easy to spend money on.
I often think back on that childhood bank and, while I didn’t fully understand it in my youth, I am grateful that my parents prompted me to start thinking about money as a multi-faceted tool. Money can be used to help others, to buy something fun today, or be tucked away until something truly amazing comes along. Just as often, I contrast that to my mother-in-law who is appalled that her son and I rotate between the same few outfits, hardly ever go out to eat, and don’t own a television. And I laugh because I choose to live like a pauper 95% of the time, so that I can afford to live like a queen when a purchase or experience aligns perfectly with my values and my goals. I am paying myself first because I love my future self and I want her to be comfortable, secure, and happy.
I can afford to make sacrifices and save aggressively now, so I do. That’s really what it comes down to. I don’t know what the future holds, and there may come a time when I can’t save as aggressively because I am out of work, have ongoing medical expenses, or reallocate fund to a new goal. Whatever happens, I feel confident that my current savings habit is setting me up for a bright future, even if I encounter several overwhelming storms along the way.