When there are credit card payments, student loan payments, rent, mortgage, car payments, utilities, groceries, …, and the good ‘ole gym membership competing for those precious budget dollars, it can be so easy to ignore savings.
In this post, I’ll show you why it’s vital to save monthly. How will we do this? By paying ourselves first. That’s right – before all of those other bills. Don’t worry, if we do this right your lights won’t get shut off on you.
I’ve heard it when doing financial counseling, my friends have said it in random conversations, and the data show their comments to be true… “After all of the fixed expenses, it’s hard to come up with any money to save each month.”
I hear this and think about death to the savings account, death to retirement, and death to financial freedom itself. And I’m not a huge fan of death to those things, so let’s remedy this, shall we? OK, great. That’s a deal.
First the numbers
In a survey of about 7,000 Americans, 69% reported less than $1,000 in their savings accounts (GOBanking Rates). Worse than that, 38% reported no savings at all! Yep, $0. The study even sites, “…living beyond their means…” as a probable reason for the lack of savings.
Regardless, the above paragraph just covers savings accounts. I shudder to even broach the ‘retirement’ topic… Eh. What the heck – let’s find out.
Same company, different survey, similar results:
33% of Americans have ZERO retirement savings (2016). I’m shaking my head… Not violently, but with clear purpose… Let’s continue. A couple of quick takeaways from the data:
- Women are more likely than men to have no retirement savings.
- 3 in 5 Millennials have started a retirement fund (Good job by us).
- But – and thank God for this for the seniors – retirement savings correlates closely with age. Meaning the older you are the more likely you are to have a higher dollar amount saved up.
Even though we’re happy for our wiser elders, that doesn’t mean we can’t try to narrow the gap.
I know and understand that saving money at a young-ish age can seem like a less-urgent task. Retirement is decades away and you may or may not have a family, a house, kids,… But please do not buy into that hype. I argue that after eliminating bad debt, there is no more urgent task than saving money – one way or another.
Why is saving NOW so important? Because there is no substitute for time when it comes to earning interest. Example (I’ll assume a 5% return here):
- If you start saving a modest $100/month at age 35. You can expect to retire (at 65) with $83,712
- Start at 30 and you’ll see $113,803. (Keep in mind you only contributed an additional $6,000 to earn that ~$30k difference)
- Have an awesome mentor and start saving your 100 bucks at 18… You’ll hit 65 with $224,430 in your account. Remember, that’s from $100/month!! Compared with 30 years of saving, 47 years will earn you an additional $141k for the price of $20k in extra contributions.
There really is no substitute for time when it comes to investing. Now that we know that savings are a huge priority, how do we tackle making it happen?
What to do to begin paying yourself first
1) Determine your goal
Are you saving money to establish an emergency fund? Or maybe you’re saving for a downpayment for your first house?
Retirement, peace of mind, or maybe just because you think it’s the prudent thing to do? Either way now’s the time to identify your goal. If you don’t know where you’re going, it’s going to be awfully hard to get there.
Additionally, it is important to determine the dollar amount needed for each of these goals. You want to eliminate the possibility of floating in savings limbo while you cycle back and forth between saving $1,000 or $2,000 for your emergency fund, for example. Zeroing in on your total amount will allow you to create a specific saving plan that has a finite end date.
Another possibility is that you’d like to save for more than 1 reason. Let’s go with a vacation and a downpayment, for example. While you’ll eventually get to both goals if you follow the proceeding steps, I’ve found that those who prioritize and execute are more successful, and reach their goals more efficiently.
Meaning, rather than dividing your monthly savings into 2 accounts, choose the fund that is most pressing and achieve that goal first. If you’d rather go on vacation before buying the new house, then top out that vacation fund before thinking about the downpayment. Once the vacation is funded, cross it off the list and move on to your next goal.
Once you have your goal(s) identified, now it’s time for step 2.
2) Establish a specific account – or accounts
Your options include savings accounts, brokerage accounts, bonds, additional checking accounts, retirement accounts, … The point is – you have options, and depending on the goal(s) you have determined, there are different accounts that may be more appropriate for you.
For example, if you are saving for retirement, then you will not be focusing on accounts that give liquidity (e.g. they do not give you instant access to your cash). These account types include IRA, 401k, 503b, and the like.
Many of these only allow penalty-free withdrawals at retirement age, and if retirement is your goal – that’s for you. With a lack of instant access, you won’t be tempted to dip into your retirement fund on a whim.
Additionally, these funds allow you access to many publicly traded stocks and other funds that have the potential to earn anywhere from moderate to high rates of return (of course there is risk associated with this type of savings – consult a professional).
If you’re saving for an emergency fund, vacation, down payment, or other short-term event, then you want instant access to your cash in the event of said emergency or when it’s time to pay up.
For this, I’d recommend a high yield savings account or even an individual brokerage account. The savings account should provide close to a 1% rate of return, which is most likely better than your checking account or mattress, and the brokerage account gives you access to the market and all its wares (funds).
Choose your investments wisely and make sure you are able to sell your funds or transfer your cash when you need to make it happen.
All of these accounts can either be set up online or over the phone, and shouldn’t take you too long at all. Just make sure you’re doing your homework and investing with a reputable company that won’t take advantage of you and your cash.
3) Set up an automatic transfer
This is how you’ll actually pay yourself first. My wife and I both get our paychecks direct deposited into our checking account, so I have an automatic transfer set up for our different accounts on each payday. This way we don’t have to think about it, worry about remembering, consider transferring less this week, or otherwise deviate from course.
Let’s return to your emergency fund example from step 1, and say you decided to split the middle and put away $1,500 for your ability to sleep at night. I’m writing this January 18 and we’ll say the goal date is June 1. That gives you about 4.5 months or 19 weeks to save up. If you get paid every other week, that’s 9 paychecks. Simple division tells you that you need to save $167 every check to ensure your $1,500 is saved by the start of June.
Now that you know what’s needed, you can set your automatic transfer for $167 every payday into your new account. Because paying yourself first means paying yourself FIRST, this means you’re not considering what this saving will do to your budget. You’re determining what amount is needed and you’re making it happen. Once that’s done, we’ll move to the fourth and final step.
4) Evaluate and control the fallout to your budget
Now you’re in damage control mode.
Because saving for (insert your reason here) is a priority you’ve decided to focus on, there can be no ill feelings toward setting that money aside. People aren’t prepared for emergencies, retirement, and random life events in our country because they haven’t made saving a priority. You are making saving a priority by paying yourself first, and by doing so, other areas in your financial life may take a hit.
This doesn’t have to be the case, though. Saving doesn’t have to mean no more trips for ice cream for the kids, it just means that now it’s time for you to get creative. My wife and I eliminated $200 in normal spending one month by just making a few phone calls and asking a few awkward questions.
It is highly likely that if you took a hard look at your budget or spending habits, there are some cuts that can be made out there. Remember that you’re sacrificing in the short term for long-term stability and wealth.
Lastly, It is an empowering feeling to make you and your family’s stability priority #1.
We’ve seen that working together and paying ourselves first teaches us to live on less than we make like it’s the real normal. Struggling from paycheck to paycheck can be demoralizing at times. But if you practice financial discipline and make saving a priority, pretty soon those sacrifices will start to pay off.
The post Harnessing the Pay Yourself First Rule for Ultimate Simplicity and Financial Freedom appeared first on Dollarsanity.
