One of the most contentious and misunderstood ideas in personal finance is the idea of “paying yourself first”. It goes against how a lot of people have been handling their finances for years and any time it is mentioned there are countless people calling it dumb and reckless.
To anyone coming across the idea for the first time the general idea is that when you get your pay-cheque the first thing you spend it on is yourself. And by that it doesn’t mean treating yourself to a new pair of jeans of booking a sun filled holiday. Its referring to putting money into your savings and investments first to make your long term future better.
A lot of people are used to paying their bills first. Their pay-cheque comes in, they put a part of it away for rent, another part for utilities, another part for car payments and another chunk for food until next payday. They then go through their month/week and at the end look to see if they have any money left over, if so they put that into their savings. The problem is that most of the time, there isn’t anything left.
When these people come across the concept of saving first and then paying their bills second they reel back in horror. At first it can seem like they are being told to ignore their bills and risk getting evicted or having their electricity cut off. To see why this is not the case we need to look at a bit more of a detailed example of how it works.
Imagine a worker who gets £1500 after tax paid into their bank account every month. Their Rent/Electricity/Car/Food comes to £1200 each month. They set this aside so that they can sleep well at night knowing their wont be getting people chasing up missed payments. The £300 extra then sits in their account and over the next few weeks they spend part of it on new clothes, a few nights out in the pub and a date night with their partner. The kids then see a new toy they want and wont stop whining until they get it. As there’s still £100 left in the bank account and its only a week till payday this also gets bought. There’s a few extra nights where nobody has the energy left to cook so that results in a take away being brought in. A friend is passing by and you agree to go for a few drinks with them. At the end of the month there’s £20 left in the account and the worker feels its not enough to bother logging into their online accounts and transferring to their savings account so it gets left. The next pay-cheque comes in and the cycle repeats.
Now lets look at our financially savvy worker. They also get £1500 and have bills totalling £1200. However the first thing they do is access their savings account and transfer £200 into it. Over the month they pay out the £1200 bills as they appear and spend a bit on themselves on trips to the pub and a date night with their partner. When the last week comes along and the kids start nagging for the new toy they firmly get told no. Its harder to give into their nagging when you don’t have the option of getting the toy. The nights when you come home too tired to cook end up with someone finding the motivation to open the fridge and spending 15 minutes putting something together. The friend who visits and wants a drink gets turned into an invitation to come to your house for a coffee. At the end of the month there’s nothing left in the account.
Its easy to see that the second person has had a similar month to the first person but has ended up with £200 saved. Doing this every month soon adds up and would give the financially savvy person £2400 saved over a year. Who wouldn’t want to have that sort of safety buffer in return for a few less luxuries?
The point of this example is to demonstrate that paying yourself first results in a change of attitude to luxuries instead of bills and forces you to adapt.