Are you wondering what the hell am I going on about? You might just be mumbling to yourself – my employer pays me. I am not an entrepreneur. How do you expect me to pay myself?
My first brush with this idea was one of my earliest personal finance books – Rich Dad Poor Dad. In the book, Kiyosaki talks about it in a very interesting way as to how his Poor dad would pay his bills first and then spend the rest of the money. However, he learned from his Rich dad, that the prudent practice really is to pay yourself first and only then all the bills including credit card.
What is pay yourself first?
Pay yourself first is just a cryptic way to say save before you spend. While you can try and hanker for the best returns in the market for your money, you will be able to make a far bigger impact by increasing your savings, with every payday.
Conventional wisdom gives the equation of Income – Expenses = Savings. This advice really turns that wisdom on its’ head by making the equation Income – Savings = Expenses.
Also, loan payments even for a house do not count as paying yourself. Consider it as a bill payment to your lender.
Why must you pay yourself first?
For people who haven’t heard of it earlier, the pay yourself first philosophy might strike as odd. But, there are some really strong reasons to do just that:
1. Give priority to your future self
While I do believe in the Indian philosophy of “the future is unpredictable”, most humans have a tendency of painting a much rosier picture of it, as compared to the present or the past. We all think we will get a better paying job, a good raise and things will be easier.
However, the only way of really making yourself a priority is by putting aside money with each and every paycheck before paying anyone else. You are then working towards making your future better than your present.
2. Escape the trap of instant gratification
Here’s the thing – most of us spend money either on basics or on consumables which lead to instant gratification, be it clothes, gadgets or dining out.
The famous marshmallow experiment showed that from a very young age, you can divide humans into 2. Those who can wait for something and those, when given the right temptation, want that thing instantly. That is also the psychological difference between Savers and Spenders.
However, when you pay yourself first, whenever you log into your main bank account you see only a post-savings number. So, at least with some of your money, you manage to not give into the instant gratification of spending.
3. Regular amounts will mean a bigger saving
We all want to save and often think that we will save with our bonus or whenever there is a windfall.
However, when you pay yourself first regularly, not only does it become a good habit, but you are also bound to save more.
Consider this example. You get a monthly salary of Rs. 50,000 and it ends up evaporating in a jiffy. You tell yourself that savings will happen with the Rs. 50,000 bonus that you expect in a few months.
When the bonus is in your account, you feel good as you transfer Rs. 30,000 into a Fixed Deposit or a separate bank account, because hey, you deserve to splurge the rest of the Rs 20,000 after slogging for a year.
Now, suddenly you read this post and decide to put aside Rs. 5,000 every month. While you realize the money is still evaporating, by the end of the year, you would have saved a neat Rs. 60,000!
How to make paying yourself easier?
For someone who is not used to setting money aside where they can’t see it (like in the form of a bag or a mobile phone), this can sound like a tall order. But, there are some ways that you can make it easier on yourself.
1. Make it automatic
Have an automatic debit on your account that is timed with your salary. So, if your salary is credited on the last day of the month, have an auto debit on the salary account for the 2nd or 3rd of the month, before the usual date of 5th for EMIs.
Once it starts being debited automatically, there will be an effort involved in accessing that money. You know us humans, right? Lazy. Unless the need is really urgent, we would not want to access it.
2. Give it a cause
If you see your money accumulating into a big lump sum, you could end up wondering what to do with it and make a rash decision to spend it instantly.
That’s where goal based investing and saving comes into the picture. Know how much you are saving for what purpose. Is it for retirement? A holiday? Or the down payment on the house that you have always dreamed of.
3.Watch it grow
Do you know the gratifying thing about starting a project or raising kids? You watch it grow. Do that with your money too.
Put it in growth instruments like equity markets and give compounding a chance. Today, you can easily invest in Mutual Funds monthly through the SIP (Systematic Investment Plan) route or even in direct stocks monthly through the SEP (Systematic Equity Plan) route. Look at your numbers quarterly and you are bound to feel good about Paying yourself first.
The Pay Yourself First Budget
For me, the word Budget is synonymous with restrictions. I, for one, am not fond of the idea of giving myself targets in each spend category and ensuring that I stay within those limits. Yes, I track my spends, but that is just to tell me if there is a hiccup in a particular month.
Pay yourself first can be a great budgeting tool. Once your salary gets credited, you pay yourself first, pay your EMIs and all other bills. What is left is then what is you spend quota for the month. For me, that works far better than breaking down the budget further.
My history with Pay Yourself First
The reason I know Pay yourself first isn’t easy is through personal experience.
In my first job, I had a very low salary with very high vanishing powers. However, I managed to save on my bonus every year which then got accumulated into a good amount.
In my second job though, I barely thought about savings. Money was all about living the good life (whatever I could manage with the salary, that is). Whenever I was in the mood, I would invest money off and on in stocks and mutual funds.
It is only in this job that I am making an effort. As soon as my salary is in, I transfer funds manually into my second and only other bank account. I have also promised myself that I will start a SIP with the next increment.
How will you pay yourself first? Start today with this good habit of a lifetime. Let me know your thoughts in comments or email me at email@example.com