Many types of budgeting techniques revolve around the idea of dividing your monthly income into buckets of needs, wants, and savings. Once the necessities are taken care of, the remaining funds can either be used for discretionary purposes or invested for the future. “Paying yourself first” budgeting–also known as paying yourself first–turns this equation around, placing an emphasis on savings at the outset.
The basic idea of “pay yourself first” budgeting is taking care of your long-term objectives before turning your focus on the present day. This can be a useful framework to help you to squirrel money away for the future.
What is the “Pay Yourself First” Method of Budgeting?
“Pay yourself first” budgeting is a strategy of devoting a chunk of your paycheck to long-term savings goals before taking care of your current expenses. In essence, you are allocating money from your earnings for savings, before addressing your current needs and wants.
While savings is a significant component of other types of budgeting techniques, by paying yourself first you are placing this objective front and center. Savings now becomes your priority, as opposed to a bucket to fill with whatever monies are remaining at the end of the month. This makes it much more likely that you will remain consistent and committed to your savings goals.
You may even be currently using some features of “pay yourself first” budgeting without realizing it. Automatic deductions to a 401(k) plan remove money from your take-home pay, for instance, guarantee that these funds are used for savings instead of present-day consumption.
How to Implement “Pay Yourself First” Budgeting
Like every other budgeting strategy, the first step is to conduct an assessment of your financial situation to understand your income and expenses. In order to be effective, your budgeting decisions and savings goals need to realistically reflect your current or expected finances.
While your goal is to save money for the future, you also need to live in the present. Taking the time to understand how much you need for your necessities such as housing, food, healthcare, and childrearing costs is an essential step to take in order to make informed decisions about how much you can actually set aside.
Deciding how much to devote to savings will depend both on your current needs and long-term goals. There is no set rule, of course, though aiming to put away between 10-20% for savings is generally considered prudent financial planning. (The 50-30-20 budgeting rule, for instance, organizes your spending into 50% for needs, 30% for wants, and 20% for savings.)
Once you have decided how much to allocate to your savings needs, create mechanisms to place these funds in either savings or investment accounts for every paycheck. The more you can automate this process the better, as this will ensure that your savings goals are implemented as you intended. The rest of the money in your budget can then be sorted into paying for your necessities and purchases for your enjoyment.
What are the Pros and Cons of “Pay Yourself First” Budgeting?
There are a number of reasons to consider the “pay yourself first” budgeting method, but there are some drawbacks as well.
Advantages of “Pay Yourself First” Budgeting
(1) Savings First Mentality: The biggest advantage of the “pay yourself first” method is that it prioritizes savings and investments. This strategy guarantees that you will be taking care of your future needs, even at the expense of your current desires. Removing money from savings to take care of short-term costs is a recurring temptation for many, and by adopting this approach you are less likely to be tripped up by this potential pitfall.
(2) Cutting Down on Consumption: Paying yourself first will, by definition, limit your current consumption, but this has implications for your future decisions as well. There is a tendency for lifestyle creep to take hold, whereby individuals continuously increase their spending as their salary rises. This often leads to additional consumption purchases that do not necessarily bring satisfaction. By instituting a savings-first mindset with your finances, you are less likely to fall into this trap as your income increases.
(3) Simple and Automated: The “pay yourself first” model is a simple concept, and easily automated. Aside from automatic deductions to retirement accounts, you can set up monthly transfers to savings accounts to ensure that you are seamlessly achieving your savings goals. Other methods such as the zero-based budgeting and envelope-budgeting system are much more onerous.
Disadvantages of “Pay Yourself First” Budgeting
(1) Overextending Your Budget: Because your savings are getting the first bite of your monthly income, you run the risk of placing too much into these accounts. This can leave you in bad shape by the end of the month, struggling to meet your expenses and leaving you susceptible to overdraft fees in your checking account. This is especially the case if you are living paycheck-to-paycheck.
(2) Not Tackling Debt: By prioritizing savings, you may be neglecting paying off your debts. Especially if you are carrying high-interest credit card debts, this can destroy your finances. There is a balance to strike between saving for retirement and paying down debts, and payments for both should probably be part of your budget every month.
Conclusion: Budgeting for the Future
The purpose of a budget is to plan out your finances, covering your current costs while thinking about the years to come. The “pay yourself first” approach to financial planning will ensure that your future needs are prioritized, even at the expense of your current desires.
By adopting this method, you are committing to undertake a forward-looking approach to your finances, saving now and spending later. This can pay dividends down the road, helping you and your family to reach your long-term financial goals.
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