Paying Yourself First
What is Paying Yourself First?
Paying yourself first is one of the most important personal finance concepts. It is a method of allocating your income in the opposite way to what most people intuitively do.
You’ll find this concept mentioned in many personal finance books, such as the Richest Man in Babylon and Rich Dad Poor Dad.
Reversing our inclinations
The natural tendency of most of us is to pay others first. We are inclined to spend on our needs and wants first, then save and invest the remaining sum.
When you receive income and decide to spend money first, you are paying others first.
You pay Apple for that new phone, you pay Sony for that PlayStation, you pay the restaurant owner for the food.
But when you receive income and decide to save and invest the money first, you are paying yourself first.
Why? Because over time, your investments appreciate in value or generate cash flow, and that pays you back extra.
Does it actually work?
What’s the big deal about switching the order of investments and expenses? That doesn’t really make any change, does it?
The reason it works comes down not to to our spending psychology. The human brain is not particularly great at long-term prioritisation. People almost always spend more than they truly need to, if permitted. Conversely we also always find a way to spend less than it needs to if constrained.
The simple act of flipping the order of how we allocate our income can make a huge difference.
When you’ve already set aside money from the start, you essentially force yourself to survive off the remainder. What you’ll quickly find is that, unless you’ve already been living an incredibly frugal lifestyle, your spending habits will be able to adjust to a reduction in available funds. You will naturally cut out unnecessary expenses and realize that your preconceived notion of how much money you actually need was wrong.
If this method seems a little restrictive, it’s because that’s exactly what it is.
But it’s a restriction that you put on yourself, just like any other form of discipline. Will there be times when it will be painful to not be able to spend as much as you want? Yes. But it’s a sacrifice that future you will be grateful for.
Creating a system to pay yourself first
The pay yourself first concept is rooted in delayed gratification – forgoing present spending for future returns on investment. With that in mind, we can already expect that there will be some times when your mind wants to spend more and invest less.
The best way to ensure that you always pay yourself first is by setting up a system that runs independently of you.
Automatic transfers
The easiest way to take willpower and effort out of paying yourself first is by setting up an automatic transfer of your income away from where you can spend it.
For instance, set up a recurring monthly deposit from your bank account into a separate savings or investment account on the same day that you receive your income. This effectively automates paying yourself first.
There will be days that where you receive income and feel like spending more instead of investing more, because of the delayed gratification. Do not let your moods interfere with your better judgement. The way you solve it is by taking yourself out of the equation entirely through automation.
Even if you’re not investing the money right away, you can transfer it into a separate savings account. Perhaps one that isn’t easy to access for spending (to avoid yourself dipping into those funds for your impulse purchases).
Eye on the future
Paying yourself has never been, and will never be glamorous. It implicitly involves sacrificing current spending for future earnings. But know that because you are investing, the future rewards are exponentially greater than the ones you sacrifice in the present.
Due to the power of compound growth in investing, every dollar you of spending you forgo spending accumulates to more than a dollar in terms of future returns. This is why paying yourself first is so effective in the long term – you get out more than you put in. So keep your eye on the future and take investing action in the present.