One Step Budgeting & The Power of Paying Yourself First
Everyone’s told you to budget right? Maybe you even have one that you follow – well sometimes at least. I get it, budgeting isn’t the sexiest thing in the world, and the value of tracking your expenses to the penny can often seem both daunting and of little use. What if I told you there’s a technique that you can use to take the pain out of budgeting? It doesn’t take much time or effort, and the best part is that it basically guarantees itself to be useful.
Pay Yourself First
The technique is called “Pay Yourself First,” and it’s advocated for by a wide swath of financial professionals from the most conservative to the most risky. The principles behind it are hard to deny because the ultimate goal is to make yourself wealthier in the future which basically everyone agrees is a good thing.
The Pay Yourself First approach to budgeting recognizes that we are really bad at conceptualizing the future. Sure we want to richer, but will stashing away that $100 now actually help us…after all it’s such a small percentage of what we’ll need to retire on, right? So Pay Yourself First makes you think outside the present and future and pretend that your future self is another person entirely.
Future you is someone you care deeply about, but right now future you is destitute. Oh no! We better set aside some money for them. In fact, we care about them so deeply that we better set aside some money for them before we do anything else. We should pay them first. Anyone with a 401(k) already knows this trick. When the money comes out of your paycheck before you see it, you adjust your life to the new number on your paystub pretty quickly and don’t even miss the older, bigger number very much.
Pay Yourself First works the same way, but on a larger scale. You start with the number you want to save every month and you make it happen, no matter what. Just like you know not to take money out of your 401(k), you invest as soon as each paycheck comes in, leaving your account skimmed prior to spending anything. It might take a little getting used to, but it’s drastically different than the way most people budget.
How Is This A Budgeting Technique
Most people take their salary (say $4000 a month as an example) and then take taxes and 401(k) and healthcare out immediately through their employer. Depending on what state you live in, now you’re at like $3000 a month. That’s $1500 a paycheck if you get paid twice a month, or $1384 every two weeks if you get paid bi-weekly (which the majority of America is). Unfortunately, that’s where Pay Yourself First stops for most folks.
The most ardent (we’ll call her Person A) work hard to budget using dozens of categories and spending targets, meticulously tracking their spending, while the least ardent (Person B) spend until the money runs out. Pay Yourself First saves Person A time and Person B money. While it’s true that if you have a meticulous budget and you can stay under it every month, you’ll end up saving a little more money long term. But considering how few people can do that, Pay Yourself First is a great strategy for the less financially inclined.
So Now What?
Let’s implement Pay Yourself First with our example guy. He brings home $1384 every two weeks. He’s already saved a little by putting money in his 401(k), but he wants to max out an IRA too. That’s $5500 a year (in 2016…the numbers will increase over time), but he never seems to have $458.33 just lying around at the end of the month ($5500 / 12 = $458.33). So instead he saves it first.
He goes into Vanguard (or whatever company he uses for his IRA) and sets up an automatic transaction to happen the Friday after he gets paid (since his paycheck comes in on Thursday). So every two weeks $211.54 gets withdrawn from his bank account, leaving him with about $1172 per paycheck. If he has other goals, he can save for them first too, but now he’s readjusted his life by thinking about $1172 as his base pay instead of $1384.
He’s successfully paid his future self. He’s automated it, so it takes virtually no effort. He’s avoided having to budget at all because he met his saving goals before spending a penny. And future him will be thankful. All in all, a job well done. Of course, if he still wants to budget or has any money left over at the end of the month, no problem. He can save that too. My recommendation is always to take the entirety of the 25th and 26th paycheck (during the two months you get paid three times) and stash them away. After all, you lived on two paychecks a month for the other ten months of the year, didn’t you?
Nathan is the Chief Financial Advisor at Monte Largo Financial