Pay-Yourself-First Budget: Definition, How it Works
You may not have heard of a pay-yourself-first budget. But just as it sounds, it means that you pay yourself first to achieve your savings goal before expending the remaining funds the way you want.
This pattern of budgeting has lots of positive sides, but it also has its negative sides too. We’ll discuss in totality how this budgeting works, and help you decide if you should consider it
What is A Pay-Yourself-First Budget?
A pay-yourself-first budget is a type of budgeting that involves you saving a huge part of your income – handling your savings like a separate bill – and then spending the rest on personal expenses, and other things you want.
Having a pay-yourself-first budget is not as difficult as other budget types as you do not need to input lots of time in tracking your expenses. So long you keep prioritizing covering up your bills, making savings, and avoiding debts, you’re good to go.
For instance, if you have a target to save 20% of your earnings per month – 10% for retirement, 5% vacation fund, and 5% emergency fund. You can then move on to spend the remaining 80% on your wants and needs.
A certified financial planner and founder of The Ways of Wealth, R.J. Weiss said concerning budgeting: My preferred budgeting method is reverse budgeting.
Weiss said that this method applies when you are attending to the financial needs of your goals first. For example, house down, savings, travel fund, and so on, and then divert what’s left to your wants. “This way, one takes care of their goals, ideally through automatic transfers, and then can freely spend what’s leftover,” he said.
How Does a Pay-Yourself-First Budget Work?
With a pay-yourself-first budget system, you’ll automatically set some money aside to attain your money needs once you receive your paycheck. You can automate the money to directly go into your savings account, 401(k), IRA, and different other investments first. The remaining is therefore directed into satisfying your pleasures.
This budgeting method is a low-maintenance budgeting method as it does not require that you track every single penny you spend. So far you are attaining your savings goals and not over-drafting accounts or increasing your debt rate, then you are doing just fine.
The 50/30/20 budgeting rules and the 80/20 rule are two different types of pay-yourself-first budgets. With these two methods, 20% of your earnings go into savings while the rest is used to satisfy your needs and wants.
For instance, if you earn $5,000 per month and your savings goals are to:
- Attend to your Roth IRA this year with monthly contributions of $500 as a 49-year-old person ($6,000 annual contributions of up to 49 years old, $7,000 for 50 years and older).
- Save monthly pay of $400 each month for a house down payment.
- Put a monthly emergency fund of $200.
- Stash a vacation fund of $100 a month in all, it’ll demand that you need $1,200 per month, giving you a 24% savings rate (,$1,200 / $5,000 = 24%).
- The other 76% or $3,800 will thereafter be used in covering your regular and variable expenses including groceries, rent, phone bill, utilities, and eating out.
Are you struggling to meet your huge savings goal?
An easy way to meet these goals is to break them up into biweekly chunks. But this is largely determined by when you’re paid. It could be monthly if you’re paid monthly – for easy tracking. For example, for you to max out your Roth IRA, having a current contribution limit of $6,000 annually, your savings goal would be $500 each month.
How To Build a Pay-Yourself-First Budget
To achieve a pay-yourself-first budget, these five-step processes will help.
1. Create a Budget
To create a Budget it is necessary to use a pay-yourself-first budget to religiously track your budget. However, you need to have a budget so you can have a baseline for how much you will be paying yourself. While kicking off, review your bank and credit card statements and add up your bills
There would be high possibilities of unstableness in your monthly expenses, so you may want to add up your purchases for a period of 90 days or 12 weeks, and then average the figure to give you a number that is close to being accurate.
2. List Your Savings Goals
This part is more fun, and it involves itemizing your savings for every month. Following the past example, if you have a leftover budget of $400, $100 may be directed in an emergency fund, $200 directed in your retirement account, and another $100 towards your credit card debt. The remaining part of the payment can thereafter be spent the way you like.
3. Automate Your Transfers
Once you have been able to figure out your savings goals, create some time to set up automatic transfers to build your savings. Automate your transfers to grow your savings accounts, checking accounts, IRAs, and other Investment accounts to match the period you receive your paycheck. You may also set up 401(k) withdrawals with your employer.
4. Enjoy The Remaining Part Of Your Income The Way You Want
One of the biggest benefits of a pay-yourself-first budget is that you do not have to exhaust yourself doing lots of thinking over your spending in certain categories. Once your savings are figured out, the rest can be spent the way you want without necessarily thinking about it.
5. Adjust Where Necessary
If your income appears insufficient to meet up your wants and needs per month, find ways to reduce your fixed expenses and adjust fun spendings too and find ways to increase your income.
After taking these steps and still not in the green spot, then you may want to reduce some of your savings and debt payoff targets till you can create a balance. You will be able to sustain that for some time till you can kick those goals back up as soon as your financial situation gets better.
How Should I Pay Myself?
When creating a pay-yourself-first budget one thing you may want to figure out is; by what percentage should you pay yourself?
Many finance experts have suggested that 20% of your monthly earnings should go into your personal savings. But in reality, this method is quite hard to do. You may be living paycheck-to-paycheck or be at a point where you save 5% of your income—and that’s okay. It is much better to save just a few dollars each month than not to do anything at all.
In fact, just by being faithful to paying yourself from month to month, you will finally be able to save more money each month.
Pros and Cons of a Pay-Yourself-First Budget
Below are the pros and cons of pay-yourself-first budget:
- Helps to prioritize savings. An upside of this method of budgeting is that you can attain your savings goal and live the best of your life.
- A system of budgeting with low maintenance. You do not have to bug your head about how high or low your expenses could be. You can confidently expend the remaining part of your funds into whatever you want, so long as you have attended to your budget and savings first.
- Budgeting can be automated. One of the topmost rules about this budgeting method is to automate your savings through automatic transfers so that you do not need to make a different decision that could hamper achieving your goals.
- It can be quite rough if you are living paycheck to paycheck. You may have almost no area to wiggle around in your budget so you can pay yourself without incurring additional debts or overdraft. You may want to try out using an envelope, then switch to a pay-yourself-first budget once you have some breathing room in your budget to save.
- It could result in undisciplined spending. When you lavish on your wants after paying yourself first, you may be overlooking vital areas of your finances that need to be refined and help to attain your savings goal faster.