Well, folks, the numbers are in and they aren’t pretty. You may have seen some of them. Half of Americans couldn’t handle a $400 emergency without selling something or borrowing from a friend. A third of non-retired adults have no money put aside for retirement. Student loan and credit card debt are trillion-dollar industries.
The bottom line is that we, as Americans, are horrible with our finances. We spend when we should save, and we save when we should be investing. Many of us don’t do either, charging through our best years buying the latest electronic devices, eating out ever night, or going on expensive vacations.
But whatever the reason, the real tragedy is that we spend decades treading water financially for no reason. There are a host of tools out there for us to use to slay the dragon and get the gold. One of them stands head and shoulders above the rest. If you could only do one thing to straighten out your financial life, it should be to pay yourself first.
Most people are spending 105-110% of their gross income. This forces them into a spiral of debt to pay for vacations, Christmas, or emergencies. If they’re lucky they can get their credit cards paid off before the next time they are presented with an excuse to use them again. But often, they aren’t. Each year the debt load inches higher until it becomes a way of life.
By paying yourself first, you can reverse the process. Slowly, without noticing a change in your life, you can go from living above your means and using debt to make up the difference, to living below your means and having a happier, more fulfilling life. Adopting the habit of paying yourself first is an important step to making that a reality.
What Does It Mean?
Most people get paid and then pay their bills. The money that is left over gets thrown into entertainment and luxuries. What little is left after that seems too small to throw into savings, so it gets frittered away. With the next paycheck, the process starts all over again.
When you pay yourself first, as soon as you get paid you put a percentage of your paycheck into a checking or savings account. Then pay your bills. A common result when you first start doing this is you find yourself not having enough left over for all the things you use to do. That’s a good thing. You were probably “running hot” with your finances and shorting your future self in order to have things that you didn’t really need.
When you commit to paying yourself first, some things will naturally fall by the wayside. You might go from eating out five days a week to only once a week. Maybe some subscriptions that you were paying for get cancelled. Cough, gym-membership-you-haven’t-used-in-five-years, cough! Everyone has their “sacred cows” that they aren’t going to get rid of no matter what, keep those. Just let go of the other things that have been kicking around in the background unused.
How Do I Do It?
This is really the meat of the problem. It can be extremely difficult to break out of your old habits and get the ball rolling. For many, the barest necessities are more than 90% of their income. In this day and age, it is very easy to get behind the eight ball with rent, car payments, and credit card debt.
First, start small. Either pick a low number like 5% or commit to giving up something for a month and put that money aside. If skipping a few nights out on the town doesn’t cause the Earth to crash into the Sun, do it again for a second month. By then you should be ready to stretch yourself a little bit and increase the amount you are saving.
Second, talk about it. Alot. Whether it’s coworkers, friends, or family members, tell them what you are doing. Even if they are skeptical of what you are doing, they will automatically become your accountability partners. Considering the sad state of financial literacy in America, you will probably be unique within your circle of friends. Whether people are cheering you on or criticizing your efforts, being open about what you are doing will help keep you on track.
Third, reward yourself. By setting milestones and giving yourself small rewards along the way, it becomes much easier to stay on the path. I use the ten percent rule for my rewards and for milestones I usually go with $500 or $1000, depending on what I’m doing. So, every time I hit a milestone, I take ten percent of that money and treat myself.
If you do start by paying yourself less than ten percent, over time you can work your way up to that mark. If you couple this strategy with a debt rolldown plan, you can simultaneously pay off a sizable chunk of debt and build up a sum of money to begin investing with.
What Do I Do With All This Money?
Great question. There is no hard and fast answer though. Considering the statistics I mentioned at the beginning of this post, putting the money towards a financial foundation is probably the best answer for most people. Once you get to that point, there are a world of options available to you. These range from your own business ventures to investing. Ultimately, that is the subject of another post.
Developing the habit of paying yourself first is a powerful tool – possibly the most powerful tool – for building wealth. By taking ten percent of your income and setting it aside before you pay any of your bills or buy anything, you will build a reserve of money without noticing it. This money can protect you from emergencies (small and large) or go out and make more money for you. When used with other financial habits, your results will be out of this world but even if you just do this, you will take your finances to another level. Start now!