When you receive a paycheck, who do you pay first?
If you’re like most Americans, you’re probably paying everyone else first—your rent/mortgage, groceries, utilities, car payment, insurance, etc. Once you’re done paying all those bills, you stick whatever you have left (if anything) into savings—that’s the classic “paying yourself last” scenario.
And like most people, you then patiently await your next paycheck and repeat the process all over again. But if you ever want to get out of the rat race, then I’m here to tell you you’re doing it wrong.
The philosophy of paying yourself first came from George Clason’s book, The Richest Man in Babylon, which was written nearly a century ago. And its message still holds true today, despite how the world has changed. In fact, Nasdaq has named it the No. 1 proven way to save money.
People who choose to pay themselves first allocate money to the asset column of their balance sheet before they’ve paid their monthly expenses. Essentially, you set aside a specific amount of money right off the bat, and then live off what’s leftover. And that’s how wealth grows.
If you aren’t doing this now, have no fear—it’s never too late to ditch your bad habits. Learning to manage your money properly now with a “pay yourself first” mindset will ensure you have it to invest later.
How Kim and I Pay Ourselves First
The most important rule to paying yourself first is making sure that every dollar you set aside for investing stays in your investing/asset column.
This can be challenging for a lot of people who find that once they pay all their bills, and then spend money each day on food, gas and other living expenses, they have nothing left at the end of the month. I know the feeling well because that was our financial situation years ago.
Kim and I finally came to realization that if we didn’t start putting something aside for our investments—for our future—then we’d end up with nothing. So, we created a plan and the first part of the plan was to commit to this:
For every dollar that came into our household, no matter where it came from, we would take 30% off the top.
In other words, we decided to pay ourselves first, before paying anyone else. If $100 came in, then we put aside $30. If $1.00 came in, then it was 30 cents.
The second part of the plan was to divide the 30% into three accounts, which at the time were piggy banks. The three piggy banks were labeled:
- Savings Account (10%)This account is a cushion for unforeseen emergencies or special opportunities that improve your life.
- Investing Account (10%) These are funds untouched while we looked for a great investment opportunity.
- Charity or Tithing Account (10%) As the saying goes, “Give and ye shall receive.” Another saying I heard is that “God doesn’t need to receive but humans do need to give.” Charity is a powerful tool with many benefits to all involved. One line of the Rich Woman’s Creed is “I am grateful.” It’s very gratifying to share what you have and be of service to others.
After we took the 30% off the top, the remaining monies went to pay our bills. Paying ourselves first did not mean that we spent that 30% on clothes, nice restaurants, and vacations. Paying ourselves first meant that we were creating our financial future.
The key to making this plan work was that we committed to do this with every dollar that came into our household. It would have been easy to slip back to old habits and dip into that 30% from time to time, or to say, “We really need a new couch, let’s skip the piggy banks this month.” The magic comes from the discipline of doing this with every dollar and sticking to the plan every month.
How to Pay Yourself First
When you begin paying yourself first, it will feel totally backwards because you’ve been doing it wrong for decades. But trust me, it’s the only way to go. Kim and I have had many bookkeepers and accountants who have balked at our approach, because they too have grown accustomed to paying themselves last.
Even during times when my cash flow was less than my bills, I still paid myself first. And you can too. How?
First, don’t get into large debt positions that you have to pay for. Keep your expenses low. Build up assets first. Then buy the big house or nice car later—learn to delay gratification.
Second, when you come up short, go ahead and let the pressure build—don’t dip into your savings or investments as a bailout.
You see, poor people have poor habits. And one of those poor habits is dipping into savings to pay bills. Use the pressure to inspire your financial genius to come up with new ways of making more money, and then pay your bills with that.
So let’s say you’re taking home $4,000 a month. If you first pay yourself $500, then you have $3,500 left for living expenses. After one year’s time, you’ll have saved $6,000. You can even set this up automatically with your bank, to remove the temptation of spending the money.
But How Can I Save When I Have Debt?
Kim and I had about $400,000 of debt when we started our lives together in 1984—but by 1990 we were debt free. Here’s how we did it, and thus, here’s my advice for you:
Step 1: Immediately stop accruingbad debt. Stop adding to your credit card balances.
Step 2: Make a list of all the debt you owe (credit card, school loans, car loans, IOUs to people, your personal residence, etc.) so that everything is clearly organized and accounted for.
Step 3: Hire a bookkeeper so you can’t hide from the truth—he or she will keep meticulous records each month, so you always know where you stand (even if you don’t want to admit it).
Step 4: Determine the order for paying off each debt by starting with the lowest and working toward paying that off. For all other debt, just pay the minimum amounts due each month. Once your first (lowest) debt is paid off, then work on the next debt (second lowest) and so on.
Step 4: Use the “Pay Yourself First” method that Kim and I used.
Remember, you have to stick to this plan every month. If you say to yourself, “I’ll go off the plan just this month,” then you won’t form the habit and your debts will not go away.
Today, Kim and I are richer, not just because we have a lot of money—but richer from the experience and the lessons we learned digging our way out of debt.
And once you get your personal finances under control, you may be ready to go out and look for sound investments to grow richer.
Editor, Rich Dad Poor Dad Daily
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Source: Daily Reckoning