Budgeting can be a puzzle, and understanding the concept of “paying yourself first” can make all the difference in achieving your financial goals. In this FinPlan article, we’ll explain reverse budgeting, or “paying yourself first,” and clarify how it differs from saving what’s left of your income. Let’s unravel the mystery of this transformative approach to managing your finances.
Traditional Budgeting vs. Reverse Budgeting
Traditional Budgeting: In a typical budgeting approach, you allocate your income to cover your expenses, such as rent, bills, groceries, and debt payments, and then save or invest whatever money is left over. The issue with this method is that it often leads to inconsistent or minimal savings because expenses have a way of consuming available funds.
Reverse Budgeting (Pay Yourself First): With reverse budgeting, you flip the script. You prioritize saving or investing a portion of your income right at the beginning, before allocating money to your expenses. This means that you pay yourself first, as if you were one of your regular bills. The rest of your income is then used to cover your expenses and any discretionary spending.
The Benefits of Paying Yourself First
- Consistent Savings: By making savings a non-negotiable expense, you ensure that you consistently put money toward your financial goals.
- Prioritizing Your Future: Paying yourself first shows that you value your financial future and prioritize long-term financial security.
- Less Stress: Knowing that you’ve already secured a portion of your income for savings can reduce financial stress, making it easier to manage daily expenses.
- Automatic Progress: Your savings grow without the need for constant decision-making or discipline, as it’s already baked into your budget.
- Increased Accountability: Paying yourself first forces you to be accountable to your financial goals before other expenses tempt you.
How to Pay Yourself First
Let’s break it down with a practical example. Assume you have a monthly income of $6,000:
- Set a Savings Goal: Determine how much you want to save or invest each month. This could be a percentage of your income or a fixed amount. For instance, let’s say you aim to save 20%, or $1,200, each month.
- Automate Your Savings: Set up automatic transfers from your checking account to your savings or investment accounts. This ensures that your savings happen without fail.
- Budget with What’s Left: Now, allocate the rest of your income to cover your expenses, such as rent, utilities, groceries, transportation, and entertainment.
- Track Your Spending: Monitor your expenses to make sure they don’t exceed what’s left after paying yourself first.
The Difference It Makes
Paying yourself first provides a powerful shift in mindset. It demonstrates that your financial future is a priority, rather than an afterthought. This approach encourages consistent savings, promotes financial discipline, and accelerates progress toward your financial goals.
Consider this: If you were to save whatever is left of your income after expenses, you might find that there’s often very little to save, or even nothing at all. Paying yourself first flips the equation, making savings a primary commitment, and turning what’s left into your spending allowance.
Reverse budgeting, or paying yourself first, is a proven method to take control of your financial future. It ensures you’re actively working toward your goals and building a financial safety net, regardless of your monthly expenses. By making savings a priority and automating the process, you can experience the satisfaction of watching your savings grow while achieving greater financial security.