Education : Pay yourself first! - Why you should do this!

5 sty 2021

What is the Pay Yourself First - philosophy?
Paying yourself first is a savings strategy that implies you should save or invest a portion of your income before spending it on other things like bills, groceries, dining out, accessories or anything else you tend to spend your hard earned money on, as part of a savings plan.

In other words, the moment your paycheck comes in, whether it be on daily, weekly or monthly basis, you skim a part off and dedicate it to saving or investing, this can be a percentage of your income, a fixed amount, or anything above what you need for your budget. (more on that later in this article)

The benefit of doing this in the long run is compounded interest, or compounded returns. See in the chart what Albert Einstein and Warren Buffet had to say about this if you need any motivation.

Why should you do it?

• Research on savings indicates that a relatively small percentage of Americans follow the "pay yourself first" adage. In fact, the Federal Reserve reports that in 2019 (the most recent figures available) less than 40% of Americans could not cover a $400 emergency in cash.
  
• If due to circumstances, your income would decrease or totally disappear (think of COVID-19 and the shutdown of business), you need something you can be able to fall back on.
  
• It is also important to set money aside for retirement. With an ever aging population, there will be high pressure on pensions and it's very likely that you won't be able to maintain your current lifestyle with your pension fund.
  

The advantage of Paying yourself first and saving or investing is that you are able to build up a nest egg for your pension or shelter yourself with an emergency fund that can weather unexpected circumstances.


How much should you save/invest?
This is very personal and I'm not a financial advisor who can consult you on this. There are however some guidelines I can give you which should help you determine the answer to this question.

First of all, you need to know how much you spend and on what. If you have no idea about your spending habits, I strongly suggest you start journaling every little cent you spend for a period of 3 months. You could do this in an Excel sheet or use one of the many apps that are available for your mobile phone.

Once you have done that, you'll know what you spend your money on and you can start digging into which expenses are inevitable, and which you can avoid or reduce (do you really need a subscription to Netflix, Amazon Prime, Hulu, Spotify and all that other stuff?). Remember, that every sacrifice you make now, will result in a much bigger return in the future, you are investing in yourself.

Depending on your situation, you will come up with a (fixed) amount, or a percentage of your income that you can do without, as if you have never received it. As a general guideline, I would suggest to start with 10% of your paycheck, and re-evaluate on a yearly basis, but this is all up to you. This money will be the building bricks for your future wealth and once you get started, you will see that it gets addictive and you'll want to save more and build that reserve faster.

What should I save/invest for?
We need to distinguish 2 goals here, an emergency fund to cover unforeseen situations on one hand, and a nest-egg, for your (early) retirement.

The first thing to do is to build that emergency fund, a strategic reserve as it were. General guidelines say that it should amount to what you need to survive for a minimum of 3 months, but I would strongly suggest to gather enough for 6 months or even 1 year of expenses. You don't need as much as 3/6/12 monthly incomes, when push comes to shove you can survive on the bare minimum and as long as you have shelter, clothing and food and a minimum of comfort you can get through that period. Your budgeting exercise should help you to determine how much is needed here. You'll want to keep these funds at hand, save or invest it in something that can easily and quickly be converted back to cash.

When you have that in place, you can build for your future, really start building your wealth, so you'll start routing your savings into other vehicles that have higher returns and can compound over time.

What should I invest in?
Again, I'm not a financial advisor, so you'll have to do some research yourself here. Savings accounts barely generate any returns these days and the same goes for bonds, so you'll need to look out for other, more rewarding investments like index funds, commodities (gold, silver), retirment savings plans with tax benefits and maybe even dedicate a little to more risky assets like cryptocurrencies (BTC, ETH).

Keep these things in mind!

• Consistency is key, you need to create the discipline to set money aside every month without hesitation, no matter what happens.
  
• Avoid debt, if you have credits (apart from a mortgage), dedicate what you save to paying these of first. There is no point in trying to accrue interest on one side, when you pay it on the other side. You can pay with a credit card if you have benefits from it (cashback, insurance, airmiles), but make sure to pay it back in full before you start paying (brutally high) interest on the outstanding amount.
  
• Think twice about everything you buy, do you really need the latest model iPhone every year, do you really need a new car because the neighbor just bought one? Spend wisely!
  

Financial education is important and is not taught in any school, if you have kids, please make sure to teach them how to be financially wise, they will be very grateful.

OK, I think that by now I have given you a good idea of why you should pay yourself first. Were you already doing so? Did I convince you to do it? If not, why not?

Let's open the discussion in the comments, I look forward to learn what are your thoughts.
Oh, and if you found this useful, a like would of course be appreciated.

Thanks for your visit, hope to see you again soon!
Nico