Pay yourself first.  This is the wisest thing anyone ever said to me.  I heard this counsel at a time in my life when I was dealing with the phenomenon of vanishing money.  Every month, a certain amount of money would go into my bank account.  By the end of the month, all of the money was gone and I couldn’t always explain where it had gone or what I had spent it on.  I believe a lot of people struggle with this issue.

Smart people, no matter how much money they have or how much income they earn, live on a budget.  On the one hand, they have a stack of bills every month.  On the other hand, they have an income.  In between those two hands, they have a budget, a plan for how they’ll spend the money.  Paying yourself first is about putting your long-term financial goals at the top of your budget list and automating payments toward those goals.  This is the single best strategy I’ve ever discovered for building lasting wealth.  Let me show you how to do this.  

 

WHO NEEDS TO PAY THEMSELVES FIRST?

If you’ve already accumulated so much wealth that it will be around after you’re gone, you may not need this counsel.  But for anyone looking to build long-term wealth, what I’m about to describe could be a real game-changer.  Even people with substantial wealth probably have children or grandchildren who could benefit from this approach.  

Over the last decade or so, I’ve worked with literally dozens of families.  Nearly all of them have had the same goal – to achieve complete financial independence so they don’t have to think about money.  For most of these families, the number one factor that will determine whether or not they achieve their financial goals is how much they save.  Investments matter and so do tax mitigation strategies.  But nothing matters more than saving.  Most importantly, you probably don’t control investment returns or changing tax laws.  But you do control how much you save.  

While this concept is easy to grasp, it’s much harder to actually live out on a regular basis.  When I think about the people I’ve worked with, I’ve come to recognize a few situations where the pay yourself first concept is particularly important:

  • The sandwich generation.  These are people who bear financial responsibilities for aging parents and young-adult children.  People in the sandwich generation are at serious risk of not saving enough.
  • Young people building wealth.  Many young people today face high cost of living, student loan debt and other challenges.  It can often seem as if there is not enough money to pay all the bills, have a decent lifestyle and save for the future. 
  • Children or grandchildren from affluent families.  These people often struggle to stand on their own two feet financially once they reach young-adulthood, particularly in the first few years after college graduation.   
  • People who earn a high income but can’t seem to save.  I find that some people who earn a high income are at risk of not saving enough for the long-term.  This is especially true when they deal with large student loan debt and the pressure to present a certain public image of success.
  • Anyone seeking to achieve big financial goals with limited means.  What I’m about to share will work for anyone who has big dreams but a long budget list where a lot of things seem to compete for the budget.
     
profile picture for Craig Janus
"There are many investment options today for affluent families. I enjoy digging in, doing the research and bringing solutions to the table."

HOW TO PAY YOURSELF FIRST

The plan for paying yourself first has a few simple steps:

  1. Identify your top goals.
  2. Build a budget and a timeframe.
  3. Put your long-term financial goals at the top of the budget. 
  4. Automate as much as you can.
  5. Identify and curtail sources of vanishing money.
  6. Rinse and repeat to optimize your outcomes.

Here’s what interesting to me about this process.  It works for nearly any type of financial goal you want to achieve.  Want to save up to buy a house?  This approach works.  Need to pay for a wedding or a honeymoon?  This works.  Want to take a lavish vacation or buy a high-performance car?  This works.  

But here is where I want to sound a note of caution.  I believe you do yourself the most favors when you put your long-term financial goals near the top of your budget list.  Most of the goals I described above are short-term.  It would feel great to achieve them, but they’ll do little to help you achieve complete financial independence.  

 

IDENTIFY YOUR TOP GOALS

While nearly all of my clients want to achieve complete financial independence, that means different things to different people.  Not everyone has the same lifestyle or the same values.  So I like to ask the question – what does your average day look like once you’ve achieved your long-term goals?  How will your lifestyle be different than it is today?  What will you do with your time?  Where will you live?   

While each client I serve is unique, most of them have some common goals, such as:

  • Paying off primary and secondary homes.
  • Owning comfortable vehicles outright.
  • Being completely debt-free (no student loans, credit cards, or other debts).
  • Having sizable cash reserves or investment accounts that provide enough income to support at least 20 years of reasonable living expenses.
  • Paying as little as possible in taxes. 
  • Having an estate plan that optimizes wealth transfer to heirs and charitable causes. 

To pay yourself first, I recommend that you get clarity about the specific goals you want to achieve and what your life will look like once you’ve achieved those goals.  Envision the ideal future you want to live.  It would be best if you did this in concert with people who are closest to you and whom you really trust.  It’s also important to do this with a financial advisor.

 

BUILD A BUDGET AND A TIMEFRAME

Once you’ve identified your top goals, I recommend that you build an accurate monthly and annual budget.  Thanks to technology, this has become so much easier than in the past.  I recommend that you carefully consider applications like Mint, Quicken, Acorn and others.  These applications can integrate data from your bank accounts, investment accounts and even credit card providers.  

This helps you not only build a monthly budget but also quickly reconcile how much you actually spent versus how much you planned to spend.  Quite frankly, this is where most people trip up.  It’s one thing to enter a set of numbers into a spreadsheet and call that a family budget.  It’s quite another thing to reconcile what you projected you would spend against what you actually spent.  You need accurate data or else all of your long-term projections could be inaccurate.  

To achieve your long-term goals, you’ll need a long-term plan.  For most working people, achieving complete financial independence will require a lifetime of effort.  So your expectations about how long it will take and how much you need to save should be based in reality.  This is where a good financial advisor can build realistic projections based on how much you need to save every month to achieve your goals. 

 

PUT YOUR LONG-TERM FINANCIAL GOALS AT THE TOP OF THE BUDGET

Once you’ve built your budget, I recommend that you put your savings goal at, or near, the top of the list of items you’ll pay every month.  This is the pay yourself first strategy made real.  I recognize that for people from certain religious traditions, the top-most item on the budget is reserved for contributions to faith-based organizations.  I completely respect that.  What’s important is that you move up the savings goal from somewhere near the bottom of your budget list to someone near the top.  

I also recognize that adding a new line item to the top of the budget may mean that items lower down the list will need to be adjusted or possibly eliminated.  I’ll address this concern below in the section about identifying sources of vanishing money.  But let me just state for the record that I have almost never encountered a situation where a working family could not substantially increase savings by following this strategy.  

 

AUTOMATE AS MUCH AS YOU CAN

The secret sauce to this strategy is automation.  For example, if you want to set aside $500 per month to your savings goal, I recommend that you automate that payment.  Most banks today allow for this type of automation.  You can also accomplish this through 401k contributions.  The point is that the payment to your financial future should be automatic – something you don’t have to think about or even click a button to accomplish.   

While you’re at it, I recommend that you automate payment for as many other bills as possible.  This makes your life so much easier and helps you avoid late payment penalties.  Many personal finance applications today allow you to setup automatic payments for nearly every line item on your budget.  They can also send you an alert once payment has posted.  

 

IDENTIFY SOURCES OF VANISHING MONEY

The other key part to this strategy is identifying sources of vanishing money.  This is again where tools like Mint, Quicken and Acorn really help.  In the old days, when people had problems with vanishing money, we used to recommend that they keep a daily log of what they spent or keep receipts.  These strategies were cumbersome and almost always produced flawed data because they relied on people to do things that were not easy or fun to do. 

With today’s sophisticated personal finance applications, you no longer need to track most transactions manually, as long as you are not spending a lot of cash.  This makes it very easy to spot sources of vanishing money.  Once you identify where your money is going, it becomes much easier to optimize your savings efforts by eliminating wasted spending and making judicious changes.

For example, it seems everything comes with a monthly subscription fee today.  When I’ve completed these analyses for clients, I sometimes find a client paying a monthly fee for services they barely use and don’t value.  Most of these services renew annually and clients forget they are even paying them.  Many subscription fees are innocuous enough on their own because they’re usually somewhere between fifteen and fifty dollars a month.  But add up ten or more subscriptions and you might have close to the amount you want to save every month.  

However, it’s not just subscription fees that cause money to vanish.  It’s also things like a $3.50 cup of coffee every day or eating out at expensive restaurants several times a month.  It might also be a high energy bill that could be reduced through a home automation system.  It could be paying for insurance that is not competitively priced.  It could also be a mortgage interest rate that is not competitive based on today’s rates.

My point is simply this.  Once you have the data from, say, 12 months’ worth of living expenses and you’ve categorized it into line items, you can then scrutinize every line item to ask three key questions:

  • Do we really need this and how important is it to us?
  • Are we getting the best deal possible on this expenditure?
  • What can we do to reduce this expense so we save more money?

For virtually every client I’ve taken through this exercise over the last 20 years, we’ve found ways to reduce costs and increase savings – all while still providing a comfortable lifestyle for the family.  

 

RINSE AND REPEAT TO OPTIMIZE OUTCOMES

This is not a one-and-done strategy.  I recommend that you review your budget and the sources of vanishing money at least once a year and then choose ways to increase savings, if possible.  It’s also wise to do this at the same time as you review how much progress you’ve made toward your long-term goals.  I find that once people see how much money they’ve saved, they’re highly motivated to keep going and improve their results.  This gives them the feeling that they are taking control of their financial future and that produces real peace of mind. 

 

HOW CAN I HELP?

If someone you care about is struggling with vanishing money, we should have a conversation.  There are so many great advancements in technology that make this strategy easy, effective and automatic.  But if people are not aware of them, they probably won’t use the tools or reap the benefits.  If I can help you or someone you care about implement the pay yourself first strategy, just reach out for a conversation. 

 

© 2019 Whitnell & Co.  The information contained in this article is provided for informational purposes only.