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Saving money can be difficult, especially on a tight budget. You budget for savings each month, but for one reason or another, you end up either saving less money than you intended or nothing at all.

This doesn’t have to be you. There is a time-proven method that makes saving money easy. You simply pay yourself first.

What Does it Mean to Pay Yourself First?

Paying yourself first is a simple strategy that involves treating your budgeted savings like any other bill.

You assign it a value each month and place that money in a savings account before you pay anything else.

What is a Reverse Budget?

Reverse budgeting and paying yourself first are synonymous. Each entail creating a budget, which includes figuring out how much you need to save each month, and paying yourself first.

Why Pay Yourself First?

Paying yourself first is a simple, but powerful concept that can help you get ahead financially.

Here are four reasons why you need to pay yourself first.

Prioritizes Saving

Creating a monthly budget is great, but many people have fallen into the trap of treating their budgeted savings like a buffer account each month.

What I mean is that at the first hint of trouble, they steal money from their savings to make up for overspending in other categories.

Paying yourself first, especially in an account that’s difficult to access, will help mitigate this type of behavior.

Develops Good Financial Habits

We all have limited will power.

By prioritizing budgeted savings and treating the money like it’s off limits the rest of the month, you eliminate that mindset that savings is just “extra money” in the budget. It’s not.

This forces you to be more intentional with your money throughout the month because you no longer have your savings to fall back on if you overshoot other budget items.

Over time this will become second nature and the idea of using your savings to cover for overruns in your budget elsewhere won’t even enter your mind.

Also, as you start seeing your saving account build, it should motivate you to save even more.

Prepares You for Planned Purchases and Money Emergencies

If you pay yourself first each month, you’ll build up a cash reserve that can be used towards managing your financial health and saving for upcoming purchases.

An emergency fund should be the first place you look to save money. This is a fund that you keep money in just in case a true financial emergency occurs like a job loss, medical emergency, or other major unexpected expense.

To start with, try to save a small emergency fund (~$1,000). Once you’ve paid off debt and have more income available for savings try to save 3-6 months expenses.

Once you have an emergency fund and have started saving for retirement, you can use the remaining savings for upcoming purchases.

Looking to buy a home? Create a separate savings account for your upcoming home purchase and begin putting a portion of your savings here.

Car in need of replacing? Create a separate car saving account.

How to Create a Reverse Budget and Pay Yourself First

Creating a reverse budget is just like creating a monthly household budget except you “pay” your savings bill before anything else.

Just like with any other budget preparation, your needs should be considered before savings and wants. I would consider needs those categories that you can’t live without or are required to continue earning your income.

This includes housing, some utilities (water, gas, electricity), food, transportation (if you need it for work), and any other items that might be required for work (licenses, software, etc.).

Track and Record Your Income and Spending

To start, you’ll need to record your income and spending for a month. Use these numbers to inform how much you are spending on each category.

Use these numbers to help determine how much to budget for different categories in the coming month.

For example, if you paid $1,200 in rent last month and know that it won’t change, you would estimate that rent for the coming month would also be $1,200.

Determine How Much to Pay Yourself

To start, you can get a high-level estimate by using the 50-30-20 method.

The 50-30-20 rule simply states that you should spend no more than 50% of your income on needs, no more than 30% on wants, and at least 20% on savings (savings includes debt, retirement accounts, etc.)

Using this high-level guide, you can see if your spending for the previous month was in line with these guidelines.

If they weren’t, you should consider reducing expenses for each category until you meet these guidelines.

Identify Your Specific Savings Goals

Create a list of your long-term and short-term goals. Next, place them in a list by priority.

Saving for an emergency fund and retirement should be highest priority.

Other goals could include saving for a wedding, a house, a new car, furniture, etc.

When preparing your budget, you should consider what you are saving for when trying to determine what high-level budget category it falls under.

For example, let’s say you want to save for an emergency fund, retirement, a new car, and a vacation. The emergency fund and retirement savings would be considered savings while the new car and vacation would be considered wants.

Once you’ve looked at your savings goals and determined how much you can save each month towards each goal utilizing the 50-30-20 rule as a rough framework, you’ll know how much to pay yourself in the coming month.

Pay Yourself First

Take the amount you calculated earlier for savings and pay yourself first (i.e. put this money in savings before paying for anything else).

Automate Your Savings

To simplify this process, you can set up an automatic transfer or split up your direct deposit so that the money automatically deposits into your savings account each month.

Automatic Transfer

Many banks give you the option to setup automatic transfers from one account to another. To get started you just need the following information:

Account that money will be transferred out of

Account you will be transferring money into

Amount you want to transfer

Date you want it transferred – for most people this will be the day they get paid or shortly thereafter

Once you have it setup, it will work like magic each month automatically depositing the money into your savings account(s).

Split Direct Deposit

Most companies offer direct deposit as a way of receiving your paycheck electronically. In addition, they typically also have the ability to split your paycheck into multiple direct deposits.

To get started, contact your HR department and ask them about splitting your direct deposit to multiple accounts. You’ll need the following information to set it up:

Routing and account numbers for the accounts you’d like to get setup

Amount you’d like transferred to each account

Voided check for each account you’d like setup (ask before voiding a check)

Once it’s setup, your money will automatically get deposited into your savings account(s) when you get paid.

This is a great way to setup automatic savings because, if you set it up right, you never actually see the money in your checking account before it goes to savings.

This keeps the savings out of sight and out of mind, so that you’re less tempted to access it throughout the month.

Adjust Your Budget as Needed

If you go through the month and find out that your budget doesn’t work, consider adjusting it moving forward.

For instance, if you budgeted $100 for electricity expenses, but found out that it’s more like $140 each month, make the adjustment to your budget. Just remember to try and stay within the 50-30-20 framework. If you have to increase your electricity expenses by $40, you’ll need to lower your needs or wants by $40 to make up for it. Avoid lowering your savings each month if at all possible.

A Quick Reverse Budgeting Example

Step 1: Track and Record Income and Expenses

For example, let’s say your monthly income is $4,800 and your recorded spending from the previous month was $2,880 on needs, $1,440 on wants, and $480 on savings.

This equates to 60% needs, 30% wants, and 10% savings.

Step 2: Determine How Much to Pay Yourself.

To start, eliminate any unnecessary expenses to get to the 50-30-20 framework.

After looking at your various expenses in the needs category, you’re unable to identify any needs that can be cut, so you’re left with 60% needs.

After looking at wants, you’re able to eliminate some expenses and get down to the 20% mark.

Although 60% needs and 20% wants doesn’t fit perfectly into the framework, we still have 20% savings, so our budget should still be ok moving forward.

The biggest concern with having so much of our income dedicated towards needs is that if we truly have an emergency and need to cut spending, we have less flexibility to do so (i.e. less wants to cut spending from).

Now that we know the savings meets the 20% savings rate outlined in the framework, we need to decide how to divvy up the money.

Step 3: Identify Specific Saving Goals

We’ll keep this simple. Let’s say the goals are retirement and an emergency fund. We decide to put 15% towards retirement and 5% towards an emergency fund.

This equates to $720 towards retirement (15%*$4,800) and $240 towards an emergency fund each month.

Step 4: Pay Yourself First

Either manually move $720 to the retirement account and $240 to the emergency fund account before paying anything else or setup up an automatic method for making this happen. As mentioned before, automatic transfers and splitting your direct deposit are great ways to accomplish this.

Step 5: Adjust as Needed

For this example, let’s assume that the food budget consistently runs over $50 each month due to an unrealistic estimate.

We add $50 each month to the needs category and since there weren’t any needs we could cut, we cut $50 each month from our entertainment budget to offset the food expense increase.

Effective Ways to Pay Yourself First

Cut Expense Spending and Place the Difference in Savings

As mentioned above, you should constantly be on the lookout for expenses that you can cut.

When you’re able to cut or lower expenses, don’t just replace them with new ones, bank that money in your savings.

Just Start Saving – Small Savings Still Count

You don’t have to go from saving nothing to 20% savings overnight. You know your life and finances better than anyone.

If you’re not currently in a place financially to save 20%, create a realistic and attainable goal and save what you can.

When setting your saving goals, having a goal that’s challenging isn’t bad. However, shooting for an impossible goal is only going to discourage you in the long run.

Earn More and Save the Difference

When you get a raise at work, instead of inflating your lifestyle (new car, new furniture, new suit, etc.), place the difference between your new salary and old salary in savings.

After one to two raises, you’ll be surprised how quickly the savings add up.

Dual Income Family? Live Off One Income

If you and your partner both earn a paycheck, try living on just one paycheck and placing the rest in savings.

Before implementing this, everyone should be on the same page about account access, the household budget, and financial goals.

Also, if you and your partner are planning on transitioning to one income in the future anyways, this could be a good test run and a way to build a little savings before that day arrives.

Take Advantage of Your Employer’s Retirement Plan (especially if they offer a match)

A tax-advantaged retirement account is a great place to store your retirement saving because you get the advantage of tax-free earnings while it’s deposited.

On top of that, many employers offer a match to the money you put in there, so not only are you getting tax-free investment earnings, you’re also getting free money on top of that.

For example, let’s say your employer offers 100% match up to 3% of your annual income. You make $50,000 per year. In this case, your employer would match up to $1,500 each year. To take full advantage of the match, you would need to deposit at least $1,500 each year in your employer sponsored retirement account. As long as you do that, you’re getting an extra $1,500 in free money.

What About Debt?

If you have debt, especially high interest debt, you should be paying it off first before savings.

The beautiful thing is that you can still use a reverse budget and pay yourself first. The money in your savings budget will just go primarily towards debt repayment until the debt is paid off.

Smart steps to debt repayment:

Setup a small emergency fund (~$1,000) Take advantage of employer match to take advantage of free money Only if you can still make payments on debt Pay off debt starting with the highest interest rate As an alternative, Dave Ramsey recommends the Debt Snowball (pay off smallest amount to largest amount) Once debt is paid off, set up a larger emergency fund (3-6 months of expenses) Begin focusing on retirement and other savings goals

Automatic Millionaire

It’s a little older now, but a good source of information on this subject is the book, The Automatic Millionaire. As you may have guessed, the book is focused primarily on the habit of saving, making it automatic, and how it can help you achieve your financial goals. You should be able to find a copy at your local library or anywhere books are sold.

Pay Yourself First: Save More Using a Reverse Budget – Conclusion

What makes paying yourself first so effective is that, by moving money from your income into savings first, you’re forced to live off of the remaining income.

This keeps you from considering the savings budget just a buffer account that you can dip into when you need a little extra cash.

Over time you develop the habit of saving and start to consider it a priority not because you have to, but because you want to. Your debt disappears and your savings grow which only motivates you to save more.

As your savings grow to a point where you can handle most financial emergencies, the worry you felt before is replaced by a feeling of freedom.

If you stick with it, you’ll ultimately be able to achieve your financial goals.

Do you pay yourself first? Why or why not?

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