Being able to sustain yourself financially goes beyond just making money. Although making money is key, that’s not all you have to do. You need to be able to manage the money you have earned. You must put a strategy in place to manage, save, and invest your income, whether as a business owner or a salary earner.
To achieve this, you must create a working budget that suits your financial capacity. The pay-yourself-first budget is one of the most popular budgeting methods that can help you manage your income effectively.
This post will delve into what a pay-yourself-first budget is and how you can use it as a feasible budgeting strategy to improve your finance.
What Is A Pay-Yourself-First Budget?
A pay-yourself-first budget is a typical budgeting method where you save a significant amount of your income first before spending the remaining on your expenses. This budgeting strategy prioritizes your savings goals and treats them as a high-priority bill.
A pay-yourself-first budget is also known as a reverse budget because it appears to be the opposite style of other budgeting methods. Also, it’s one of the various methods of budgeting.
To learn more about other budgeting strategies, check out this comprehensive guide on how to budget your money.
How Does A Pay-Yourself-First Budgeting Work?
A pay-yourself-first budget is a straightforward method, and it works by allowing you to save a certain amount of money from your earnings before you go ahead to cover other expenses.
For instance, if you earn $10,000 monthly. This budgeting strategy would require you to save about $2000 first, after which you can settle other bills with the remaining $8000. This means you are essentially treating your savings like a bill; a very important one at that.
Why Should You Pay-Yourself-First When Preparing A Budget?
Paying yourself first when preparing a budget is recommended because it is much easier than other budgeting methods since you don’t have to worry about tracking your expenses. Once you can prioritize savings, cover your bills, and avoid incurring debt, you are just fine with this budgeting method.
For example, suppose you intend to save only 20% of your income (let’s say 10% for retirement, 5% for vacation, and the remaining 5% for an emergency fund). In that case, you can freely spend the remaining 80% of your income without tracking your spending.
What Is The Ideal Percentage To Pay Yourself?
When using the pay-yourself-first budget, the most important question you should ask yourself is how do you pay yourself first and what percentage should be paid?
Ideally, you shouldn’t pay yourself more than 20% of your income, especially when you are not earning much money. If 20% of your salary goes for savings, the remaining 80% can cover your expenses for the month. You could even realize extra cash after covering your expenses.
On the other hand, if you decide to pay yourself more than 20% of your income, you may become financially stranded later on since the money left may not be able to cover all your expenses.
Take it easy on yourself when using this budgeting method. You don’t have to empty your bank account because you are determined to save money.
Pay-Yourself-First Budget Pros And Cons
Paying yourself first has its merits and demerits. If you must use this budgeting strategy for the first time, you need to understand the good aspects and its downside.
Quickly, let’s delve into the pros and cons of a pay-yourself-first budget:
- It’s A Low Maintenance Form Of Budgeting
With this budgeting strategy in place, you don’t have to worry about your spending habit, and you don’t even need to track your spending at all. Once you’ve paid yourself first, you can spend the rest of your paycheck however you like. This is why it’s considered a low-maintenance form of budgeting.
- Automates Your Budget
When using a pay-yourself-budget, one of the golden rules you must obey is setting up automatic transfers for all your savings goals. This means that instead of visiting the bank to save 20% of your income, you can automate the payment. So once you get paid, your savings will be deducted immediately and transferred to your savings account.
- Prioritizes Savings First
The main idea behind this budgeting strategy is to teach you how to prioritize your savings goals, thereby helping you to reach your money goals and live your best life.
Once you set up the pay-yourself-budget, you can be sure you are hitting your savings goals because nothing impedes you from saving money whenever you receive your paycheck. This is one of the pros of a pay-yourself-first budget.
- Not Ideal For Individuals Living Paycheck-To-Paycheck
If you are someone who survives only on salary, especially when the paycheck is small, this budgeting method might not be the best budgeting strategy for you. This is because your income may not be big enough to accommodate frequent savings, and you may have to find a way to increase your cash flow before you can use the pay-yourself-first budgeting strategy successfully.
- Could Promote Undisciplined Spending Habit
Once you pay yourself first and decide to spend the rest of your income however you like, it could lead to undisciplined spending, which could make you miss out on some opportunities to reach your savings goals faster.
Always remember this as one of the cons of a pay-yourself-first budget.
How To Build A Pay-Yourself-First Budget
To build a pay-yourself-first budget successfully, follow this simple 5-step process:
1. Create A Budget
The pay-yourself-first budget concept doesn’t require you to track your spending and expenses. Nevertheless, you need to create a budget to help you determine the right amount of money you should pay yourself.
That is, outline your typical expenses and how much it would take to cover them. Once you do this, you’d know how much money needs to be saved and how much should be reserved for your spending.
To start with, review your bank and credit bank statements. This would help you identify your previous expenses, which you are to subtract from your paycheck to see how much money you have left. By the time you are done with this simple math, you can discern the amount of money that should be paid to yourself first.
Creating a budget is not something you would do every month; instead, it should be done occasionally; maybe once in three months. Once a budget is put in place, it can be used to manage the forthcoming months. You may only need to make a few adjustments based on your spending habits and current expenses.
2. Identify Your Savings Goals
This seems to be the fun aspect of a pay-yourself-first budget. You have to decide what you intend to do with your savings every month. That is, list the various purposes for choosing to pay yourself first. Usually, people have three main savings goals: emergency fund, retirement fund, and credit card debt.
The amount paid to yourself would be split among these three savings goals. If you haven’t been thinking about setting up a retirement fund, you should start pondering on it right now. A retirement fund is what would secure you financially by the time you are no longer working or actively doing business.
On the other hand, another savings goal you should prioritize is an emergency fund. An emergency fund helps you take care of expenses you never planned for, such as medical bills and car troubles. You won’t have to run into debts or spend money meant for something else.
Hence, if you have $400 to pay yourself first, you can transfer $200 into your retirement fund, $100 towards your emergency fund, and $100 towards your credit card debt.
3. Automate Your Savings
Once you have identified and listed your savings goals, the next step is to set up automatic transfers to fund the savings goals. You don’t expect yourself to visit the bank every month to make payments for your savings goals. That would be unreasonable, especially in an era where almost everything can be automated.
It would be best to automate your savings so that the pay-yourself-first fund would be transferred to the designated accounts as soon as you receive your paycheck. Automatic transfers to checking accounts, savings accounts, and IRAs are compulsory if you must successfully execute the pay-yourself-first budgeting strategy.
Moreover, when choosing the accounts for your savings goals, make sure you work with a reputable financial institution. Perhaps a bank that would offer reasonable interest rates on your savings. This is very important if you intend to realize some extra money (interest) by savings for long-term goals.
4. Spend The Rest Of Your Money As You Please
Once you successfully automate your savings, you are almost done with the pay-yourself-first budget. What’s left is for you to spend the rest of your money however you’d like. This is more or less the reward of this budgeting strategy because you won’t have to rack your brain concerning how to track your spending and manage expenses.
You can spend your money without fear, knowing that you have already saved money towards your financial goals.
I still remember the first time I tried the pay-yourself-budgeting strategy. I had just left college then, working a new job. As soon as I transferred my savings to the designated accounts, I was able to spend the remaining income without feeling scared or anxious about my spending habit.
Although I wasn’t lavish with how I used my income, I spent my money freely. This is the same experience you’d enjoy using this budgeting method.
Nevertheless, irrespective of spending the rest of your money as you please, make sure you still spend wisely. Attend to your needs first before you start spending money on things that are not very important. Don’t spend recklessly because such a lifestyle is not ideal for someone who wants to manage and sustain their finance.
5. Make Adjustments To Your Spendings As Needed
The amount of money you spend on your expenses every month can’t be a fixed amount since some of your expenses aren’t fixed. This is why you must adjust your spending as needed.
Once you realize that your monthly expenses are increasing, you shouldn’t reduce the amount of money meant for your savings goals. Instead, you should cut down on some of your purchases and minimize your fixed expenses.
For example, by moving to a cheaper apartment, you are cutting down on your rent, which is a fixed expense.
On the other hand, you should examine other variable expenses and find a way to reduce how much you spend on them. Doing this would go a long way to ensure that you execute the pay-yourself budget successfully. Also, you can look for ways to increase your cash flow to strengthen your finance.
Final Notes On Pay-Yourself-First Budget
Pay-yourself-first budget is an example of prioritizing a good savings habit. If you are struggling to save towards your financial goals, one of the best ways to help is by using the pay-yourself budgeting method. This would allow you to prioritize savings and respect the financial goals you have set.
In addition, the tricky aspect of using this budgeting strategy is that you may not know the ideal percentage to pay yourself. You may pay yourself 20% of your monthly income and eventually realize that the ratio is too much, which can discourage you from using this budgeting method.
To solve this problem, you must be able to discern all or most of your expenses for the month. Once you know how much you are supposed to spend in a month, you will know the correct percentage of your income to pay yourself first.
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