One of the most useful tricks for successful budgeting is to pay yourself first.
What It Means To Pay Yourself First
Paying yourself first is the act of taking a portion of your net or gross earnings and immediately contributing it to an investment or savings account where you either can’t or won’t touch it. Some examples of this would be 401(k) contributions (see The Best Way To Invest Your 401(k)), IRA contributions (see IRA Basics), traditional brokerage account contributions, or contributions to a savings account.
Most People Do The Opposite
The majority of people operate under a “save what is leftover” mentality. The logic centers around the idea that people want to have access to the money in case they “need” it and will just save what is left over at the end of each month.
What actually happens is that as soon as we realize we have $100 “extra” dollars laying around at the end of the month we go shopping, or have a night out on the town.
Scarcity Spawns Efficiency
When you pay yourself first and lock a portion of your resources away at the beginning of each month you make your resources more scarce. What this does is forces you to match your standard of living and spending habits to the amounts you have AFTER you’ve paid yourself. If the balance in your checking account is approaching zero you will inevitably (hopefully) make fewer frivolous purchases.
You should have an emergency fund of 60-90 days worth of income built up for unexpected situations. This will provide you with the security needed to contribute more of your paycheck as soon as you get it. You may surprise yourself with how thrifty you can be, all while building up a foundation of wealth.
How To Get Started, Use Your 401(k)
A 401(k) account is hands down the easiest way to pay yourself first. If you are eligible and have not set up a 401(k) check out “How To Set Up Your 401(k)”. The reason that this method is so easy is that all you have to do is select a contribution amount and it will be taken out of your paycheck before your deposit hits the bank.
This is my preferred method because I never actually “see” the money. In other words I don’t feel like i am giving my money up by having to manually go and contribute it every month. A lot of 401(k) providers will also allow you to set up automatic increases in your contribution amount so that you can subtly start paying yourself more and more!
Split Your Direct Deposit
Another option is splitting your direct deposit. Many companies will allow you to specify multiple accounts for direct deposit. In this method you would select a savings account as your second direct deposit amount and allocate the portion of each paycheck that you want to save.
This option also works well from a standpoint of it operating on autopilot after you have set it up.
Do It The Old Fashioned Way
Lastly, you could manually move funds after you receive your paycheck. This method takes the most discipline and requires you to remember to move money into a separate account as soon as you receive a paycheck.
Make The Change
No matter which way you decide to pay yourself first, go ahead and make the change. You will be surprised at both the amount of money you are able to save (and subsequently invest), and the amount of money you have tucked away for yourself at the end of each year. This small budgeting tip is simple in nature but has the capability to drive big results.
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