Many personal finance experts and financial coaches agree that you should “pay yourself first.” But what does this phrase actually mean? In a nutshell, it means that you should prioritize saving or investing your income before paying any other expenses–that includes your rent and your bills. Paying yourself first ensures that you’re building a financial cushion. A financial cushion gives you a better chance at financial security and building wealth over time.
While this might sound counterintuitive at first, it’s a proven strategy that works. Let’s cover the basic steps of how to get started.
1. Calculate Your Income aka “Money In”
Before you can start paying yourself first, you must understand how much income you’re bringing in. Most people assess this on a monthly basis. Count all of your net income you bring in every month including salary or wages, bonuses or commissions, side hustle income, etc.
2. Calculate Your Expenses aka “Money Out”
The next step is understanding your expenses. You can utilize past credit card and bank statements to calculate your monthly expenses, or you can start a money diary and track your expenses for a month. This includes all expenses such as your rent or mortgage payment, utility bills, food, transportation, insurance premiums and more. If you have any non-monthly expenses such as annual subscriptions, jot them down and divide them into 12 months.
3. Determine Your Net Cash Flow
Subtract your “Money Out” from your “Money In” and determine if it’s a positive or negative number. If it’s:
- positive: you can start paying yourself first – continue to Step 4
- negative: find ways to increase your income and/or decrease your expenses, and repeat Steps 1-3 (Unrelated to personal finance Brian McKnight Easter Egg!)
4. Determine Any Other Financial Priorities
Once you know how much “extra” money you have each month, you can use it towards bigger financial goals. Paying yourself first means directing this amount to your savings or investments on a monthly basis (see Steps 5-6). However, you may also choose to use this extra amount to pay down debt – especially if it’s high interest debt such as credit card debt or payday loans.
5. Automate Paying Yourself First
To automate paying yourself first, take the surplus amount from Step 3 and set up a direct deposit or automatic transfer from your checking account to a savings account, or transfer it to an investment account on a regular basis, such as every month or every paycheck. (If you do it every paycheck, you’ll have to divide the amount by the # of paychecks you have per month.)
6. Set It And Forget It!
Once this is set up and you’re able to live on the same monthly expenses (assuming you have consistent income), you’ll start to see your savings and investments grow over time. This is how wealth is built!
Bonus: Increase the Amount
Whether you’ve gotten an increase in income, or you’ve found ways to cut down expenses, you may find yourself in a position to increase the amount that you “pay yourself first.” This will accelerate your financial goals and put you in a better financial position overall.
Paying yourself first is a simple yet effective way to take control of your finances by starting with small habits. Try it out and keep working towards your financial goals!
