What is pay-yourself-first budgeting? It can help you save for your retirement

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When you hear the word “budget,” your first thought may be that you need to think about all the money you have to set aside to pay others. But not all budgets prioritize spending categories in the same way. The budget you pay first has a line at the very top of the list for what is arguably your most important spending category: you.

What is a pay-yourself first budget?

Where other budgets may let you set aside money to pay for spending categories like your utility bills or groceries first, a “pay-yourself-first” budget (sometimes referred to as a reverse budget) prioritizes goal-based savings categories like retirement and investments before you make short work – term costs.

“By paying yourself first, you can avoid some common obstacles to saving, such as overspending and running out of money to save or simply forgetting to put money aside for savings while focusing on other goals,” says Heidi Johnson, director of behavioral economics at Financial Health Network.

Of course, there must be a balance in any budget strategy. You need to be realistic about how much you can comfortably afford to pay yourself while still covering your basic living costs.

How do you create a pay-yourself-first budget?

When you build a pay-yourself-first budget, you need to start changing your mindset to focus on the idea that this budget will focus on your long-term savings goals, not your short-term expenses.

If you’re looking for the pay-yourself-first strategy, here’s how to get started:

  1. Calculate your income. Before you determine how much you have available to save and cover your expenses, you need to have a good idea of ​​how much income you will have in your bank account each month. If you don’t know it by heart, comb through some of your most recent paychecks and bank statements to determine the exact amount of your paychecks, sideline activities, and investment income.
  2. Determine what your savings goals are. Think beyond covering the cost of your daily or even monthly expenses. Ask yourself what your long-term goals are and how much you need to save each month to reach those goals within your desired timeline. Perhaps your goal is to retire early or? save enough to buy a house. Once you’ve determined what you’re saving for, you can set aside a specific amount for those goals and use the leftover money to cover your daily expenses, such as paying your upcoming car insurance, rent, utilities, and groceries.
  3. Choose a savings car. Deciding where to put your savings is just as important as deciding how much to save each month. The account you put your savings in can play a big part in how quickly you can reach those goals. Pro tip: you should opt for a high-yield savings account so that your savings continue to grow over time.
  4. Periodically evaluate and adjust. While some budgeting strategies require less maintenance than others, you should still plan to review your budget regularly to determine if this strategy is still working for you and adjust your savings goals to account for changes in your income, debt, or expenses. .

“The amount of money you save will vary from person to person, depending on your income, goals, and other circumstances,” says Kendall Clayborne, a certified financial planner at SoFi. “To determine how much money you can affordably save, I recommend that you first look at your current fixed costs and spending pattern. You can then break down your goals to determine how much you need to save to reach your goal versus how much you may want to spend.

Here’s what creating a pay-yourself-first budget might look like in practice:

Let’s say you take home $3,000 each month, after taxes, and your two top savings goals are: save for a down payment on a house and build up six months’ worth of living expenses in your emergency fund over the next 12 months. To meet your savings goals within the next year, you must save each month:

  • Total Emergency Fund Goal: $10,000
    • Amount needed to reach the goal: $3,000
    • Monthly Savings Goal: $250
  • Total Deposit Goal: $35,000
    • Amount needed to reach the goal: $4,000
    • Monthly Savings Goal: $333
  • Total Monthly Savings Goal: $583

This means that after you put $583 into your savings and emergency fund, you are left with $2,417 to cover your daily expenses.

Is the pay-yourself-first budgeting method right for you?

Like most things, whether this budgeting strategy is for you depends on your unique situation and finances.

One of the benefits of using this budgeting method is that it is quite hands-off and can only take a few minutes to set up. So if you’re looking for something a little more streamlined, this could be a good option for you.

And once you know your income, your savings goals, and how much you can comfortably put in your savings account, putting those plans into action is as easy as automating your savings within your existing bank account. You can usually do this through your online bank account, mobile app, over the phone, or in person at your bank’s branch. All you need to do is select the amount you want to transfer to your savings and how often those transfers should be made, and then you’re all set.

“You can set up a direct deposit so that a portion of your paycheck goes straight into your savings account each month,” says Clayborne. And if you feel like your savings and checking accounts under one roof are tempted to overspend, you can also opt for a bank account with another bank to keep things separate and keep working towards your goals.

Advantages and disadvantages of a pay-yourself-first budget

Not all budgeting methods will work for you. By weighing the pros and cons of this method, you can decide whether it’s the right strategy for you, or whether you should go back to the drawing board.

Pro: A pay-yourself-first method reinforces a saving-oriented mentality. Instead of accounting for all your daily expenses and then looking at what you have left for your savings goals, prioritize those long-term goals first and make sure they don’t slip through the cracks.

Pro: This kind of strategy forces you to be strategic about how you use the money you have left and live within your means. It reduces the chances of falling victim to a lifestyle inflation trap and letting your savings goals slip through the cracks.

against: If you have high-interest debt, this strategy can make it harder to pay off those balances. In these cases, you may want to prioritize getting rid of your debt before tackling your higher savings goals.

against: It can be difficult to predict how much you need to save for unexpected expenses and you don’t want to create a situation where you are constantly taking money out of your savings or possibly overdraft charges, because it’s hard to predict how much you should hold in your checking account. “Most people view past expenses, such as a flat tire or a child requiring braces, as unusual, so they don’t factor in similar expenses in the future,” Johnson says. “This can lead to an overly optimistic budget.”

the takeaway

If the thought of maintaining spreadsheets and constantly working with numbers has deterred you from traditional budgeting methods, the “pay-yourself-first” method may be a viable option for you. It’s easy to set up, maintain, and adjust as needed if there are major changes in your income or financial priorities.

“This strategy usually works best for people who are tempted to spend money when they see it in their checking account,” says Clayborne. “By moving the money to another account and not seeing it as available to spend, you can fool yourself into saving painlessly — out of sight, out of mind.”

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