We’ve all heard the basic personal financing philosophy, “Pay yourself first.” The idea, of course, is that any time you receive a paycheck, or any kind of income, you set a small percentage of it aside for yourself before you start paying bills and debts. Another way to look at paying yourself is to think of it like paying a bill; it’s just something you’re committed to being disciplined about every month. First you pay yourself, then you pay the mortgage and the other bills. The intended result is that once you’ve paid yourself, you won’t miss the money; you’ll simply adjust your spending that month to the amount that’s leftover after you’ve paid yourself and your bills. At the end of the month, most people don’t remember the small, practical decisions they made along the way to manage spending, but they do remember how they much they paid themselves and they feel good as they see the amount accumulate.
As you can see, I am an advocate of the “pay yourself first” strategy. However, there are times when it’s clearly not the smartest financial choice. For example, if someone is struggling financially month to month, weighed down by multiple credit card debts, it would probably make more sense to apply as much income as possible to paying off those debts.
The definition of “paying yourself” can be comically different depending on who it is that is advising you to adopt the philosophy. A conservative financial adviser may tell you that “paying yourself” means to save some for the future. An adventure junkie may tell you that “paying yourself” means to put aside some each month until you have enough to take a trip or fulfill a dream or goal. In my opinion, there’s not necessarily a hard and fast correct answer. The right answer has more to do with an individual’s unique financial situation and goals than anything else. But if you’re interested in paying yourself, here are a few thoughts to consider:
- There’s no better or smarter way to pay yourself than making sure you’re maximizing the long-term earning power of your IRA. Not only is an IRA tax-free, any amount your company matches is like free money that grows into more free money. At a minimum, be sure to save the amount your company will match, but if you have the means, don’t stop there. Put as much you can into that IRA.
- Most companies offer an auto-draft feature to transfer money right out of your paycheck and directly into your IRA account. If your company offers it, sign up; it’s a great way to never miss that money.
- If you’re self-employed, have the discipline to deposit a piece of every incoming payment into your retirement account until you reach the full amount allowed.
- Once you’ve maxed out your retirement account contribution, it’s a great idea to build up some reserves in savings. Set up an easily accessible savings account and put a little money in each month. As a rule of thumb, a good safety net of reserves includes four to six months of salary.
- Ask yourself if you can cut back on expenses for a temporary time and transfer 10 percent to 25 percent of your paycheck or monthly income into your reserve account.
- If you have a dual-income household, see if one person can handle all of the expenses and use the other’s income for savings and investing.
- If you’re single, it’s a great time to save because you may have fewer expenses and no one else to whom you are accountable. See if you can take 25 percent of your income and put it into an account. Consider using an account at a separate bank so you will be less likely to dip into it.
- Once you’ve built up six months of reserves, you can either reduce or eliminate the regular payment you’ve committed to that account, and look for new ways to pay yourself.
- Once you’ve reached your reserve goal, anything extra can be used for investing.
- And don’t forget to live a little and pay yourself like an adventure junkie would.
Managing finances is always a balancing act, and deciding how and how much to pay yourself is a balancing act too. Consulting with an experienced financial advisor is always good advice. Talk to your advisor about your goals and ask about the smartest options for paying yourself. Everyone has different needs, but if it’s possible, start paying yourself first this month – it feels great!
Patrick Stoy has 15 years of mortgage lending experience. Patrick is CEO of Wilmington-based Market Consulting Mortgage, which he started in 2005 with a mission to build lifelong customer relationships by providing real value. To learn more about Marketing Consulting Mortgage, visit www.macmtg.com. Patrick can be reached at [email protected] or 910-509-7105.