Personal finance experts often give the advice: “Pay yourself first.” But what does that mean? And is it good advice?
Let’s start with the second question. When I first heard those words — “pay yourself first” — I imagined running a company with 10 employees. The hypothetical company had a meager month, and there isn’t enough money to pay all the employees. According to my interpretation of this advice, I should issue myself a paycheck rather than paying one of my employees — a notion that didn’t sit well with me. After all, those employees worked hard. As the owner, I should be the one to take a hit, not them. Right?
Over time, though, I realized I was misinterpreting the meaning of “pay yourself first.” Here’s a better explanation:
You are the CEO of your own life. Your employees are your bills — your electricity, gas, mortgage or rent, groceries, and more. Each of those employees performs a critical task. Groceries prevents you from feeling hungry. Electricity prevents you from groping around in the dark. Gas holds the job of keeping your car running.
But before you hire any additional employees, you need to make sure that you have enough money to pay yourself. You decide to pay yourself 25 percent of all revenues. (That’s just one suggested amount — you could save anywhere from 20 percent to 50 percent of your income). You set that amount aside each month — half into a retirement account and the other half into long-term savings goals like an emergency fund or a fund to buy your next car in cash. You issue that payment to yourself first.
With the remaining 75 percent of your money, you pay your “employees” — your bills — and if there’s still money left over, you “hire” new employees, or pick up new bills. Your “new employees” might include a cable subscription (which provides the job of entertaining you), a weekly restaurant dinner, and so forth.
Now, here’s where “pay yourself first” gets tricky. What happens if you don’t have enough money to pay yourself (save) 25 percent of all revenues? Should you stop paying yourself?
According to this philosophy: no. In fact, that will never be a question, because the first 25 cents of every dollar that comes in goes toward paying yourself. Whatever money remains is used to pay bills. Save first, spend second. By operating in this way, you’ll make sure you don’t “hire” (pile on new bills) beyond your capacity.
Paula Pant blogs at AffordAnything.com about building wealth and living life on your own terms. She’s traveled to nearly 30 countries, owns six rental units that produce thousands in passive income, and runs her own digital marketing company. Follow Paula on Twitter @AffordAnything.