The Golden Rule of Personal Finance

Every month we have money coming out of our accounts to cover expenses. Some of these expenses, such as food, housing, fuel, etc. are necessary expenses. Others are more discretionary, such as groceries, dining out, and date night funds.

The term “pay yourself first” is often mentioned as being the golden rule of personal finance. The idea is to spend money on things that matter most to you FIRST. Most of us have used the excuse “I just don’t have enough money to save or invest!” There a few reasons why this happens:

  • We spend more than we make and carry credit card balances.
  • Overspending on specific budget categories becomes normal, such as on dining out or food.
  • We are overspending on large ticket items like housing and vehicles.
  • Other areas of financial waste in our budget.

By implementing “pay yourself first,” you are explicitly defining how you want to spend your money. Let’s break down how this works and the way I approach implementing this technique.

Paying Yourself First

“Paying yourself first” means the first thing you do with your income before spending in any other category, is to deposit into your “wealth building” categories. These budget categories can include:

  • Retirement accounts, such as a 401K, Roth IRA or Traditional IRA. If you have a 401K match with your employer, don’t leave that free money on the table!
  • Emergency Fund
  • After-tax Investment Accounts
  • Saving for a down payment on a house.
  • Paying down your mortgage to pay it off early
  • Other long-term saving goals.
  • Paying off Debt

By prioritizing your money into these budget categories, you are intentionally limiting your spending on things that don’t matter as much to you.

Instead of treating your savings and investments as 2nd class citizens in your personal budget, they become “priority bills” and paid before everything else.

Paying yourself first, combined with zero-based budgeting, allows you to define how your hard-earned money works for you.

Step#1: Preparation

To pay yourself first effectively, you first need to have a solid grip on how much income you bring in and how you plan on using that income. I use YNAB to manage our family budget, and it has been tremendously helpful in giving me an accurate financial picture of our spending and cash-flow.

Implementing this technique becomes more difficult if your income varies from month to month. In that case, I would suggest going with your low range number (if not below that amount) and using that to determine your budget categories. Any earnings above that towards the end of the month would be re-distributed to your saving goals.

The difficulty in this step is to figure out how much you want to spend on each category. The more you can reduce money waste in your budget, the more money you can put towards your long-term financial goals, which will be ironed out in step #2 below.

Step #2: Iron out Priorities

Spend time thinking about your one, five and ten year goals. These will help determine what is most important to you.

If your goal is to eliminate credit card debt, this will probably be your first priority. Or it could be fully funding your emergency fund. In either case, these budget categories go to the top.

Next would be covering your most important bills. Such as mortgage/rent, utilities, groceries, fuel, etc. All the bills and budget categories that are your day-to-day necessities.

And finally, add all of your more discretionary spending. These categories include dining out, allowances, date night funds, etc.

The goal is to zero out your budget, which means that you want to assign a task to every dollar you bring in. Don’t confuse this with “spending” all of your money, because there should be categories you are using to save money. By implementing a zero-based budget, you are defining how your money should work for you.

Step #3: Implement “Pay Yourself First”

The easiest way to implement “pay yourself first” is to have as much of your budget on autopilot as possible. The below assumes you implement a monthly budget.

  • Saving Goals: These should auto transfer into your savings or investment accounts on the 1st or 2nd of the month. The sooner you get that money out of your checking account, the better! If you are paying off debt, this is when you would make your credit card payments.
  • Bills: All bills should be auto charged to either your checking account or a credit card.
  • Spending Categories: I like to put these on 1-2 credit cards. I have auto pay set up to pay off the balance every month automatically. That way I don’t have to worry about forgetting when to pay each credit card and I 100% avoid carrying credit card debt.

Using a credit card and having it paid off automatically every month also puts me on high alert to make sure we aren’t spending money we don’t have every month. If you are trying to pay off credit card balances, that won’t work. But once you wipe those out, this is one way to ensure you avoid the credit card pit of death. 

Using a credit card and having it paid off automatically every month also puts me on high alert to make sure we aren’t spending money we don’t have every month. If you are trying to pay off credit card balances, that won’t work. But once you wipe those out, this is one way to ensure you avoid the credit card pit of death. 

Implementing this technique, you will see your net-worth increase every budget period, automatically. The first few months it might require keeping a close eye on things to make sure the cycle is working as intended. And as you get raises over time, you should review your full budget to make sure things are accounted for properly. If this is done well, in theory, you could never look at your bank account or finances. But I’m not that confident or brave. ????

One other thing worth mentioning. If you can get one month ahead of your budget, where the money you earn this month is paying for your budget next month, it makes it easier to put everything on auto pilot. The main reason is because you don’t have to worry about timing bills to paychecks. You just let the cash flow out of your budget during any point of the month. Take a look at how I do this using YNAB for more details.

Benefits of “Paying Yourself First”

By saving, investing, or paying off your credit card debt on the first of the month, you are telling yourself the following:

  • These are the things that matter most in regards to my long-term goals.
  • I’m intentionally limiting the amounts in my monthly spending categories to prevent overspending.
  • If I don’t follow my budget, I am going to be spending more than I make. I better be conscious of what is going on in fear of financial death!

If you are investing or saving money as your top priority, you also provide an extra month for that money to earn interest (compared to transferring towards the end of the month).

It also is a great way to “pretend” you are poorer than you are.  I have a tendency when I have cash just sitting around in my checking account to spend it all on whatever things I “want” but do not push me towards my goals.

Taking control over your spending, instead of having your spending dictate your choices, will change your financial life.

Risks

The most significant threat in “paying yourself first” is if you don’t stick to your budget, you could easily spend more than you make and rack up credit card debt. Credit card debt will make you miserable and cancel out any gains you make by saving or investing your money.

On top of that, if you don’t have enough cash to pay your major bills (mortgage/rent, utilities, etc.), that could create more significant problems.

Creating and maintaining an accurate budget is hard. Even the most organized people have a hard time always staying under their allotted budget categories. And we all know some months fluctuate in how much we spend on specific budget categories.

Since we became debt free this month, the way I plan on tackling this problem over the next few months is the following:

  • Getting more granular with our budget. Look at past spending to determine reasonable amounts to shoot for in each category.
  • Creating a “carryover” type of fund that has a balance that I can tap into during the month. This category would be used to handle minor overages in other budget accounts. That way if we do end up overspending in a category, we have some funds we can tap into and avoid credit card debt. I’m probably going to call this category “rainy day fund.” Keep in mind this is 100% separate from our long-term emergency fund, which we will only touch under extreme circumstances.
  • Any amount leftover in the rainy day fund will either be left into that account, transferred to our emergency fund or invested.

Having access to this rainy day fund will allow us to aggressively save without feeling like we are to “tight.” Some people think this is not a smart move because we are budgeting a category without a clearly defined purpose, and it might cause us to more easily overspend other budget categories when we don’t need to.

I think this concern is valid. However, keeping an eye on spending patterns and how often we are dipping into this rainy day fund should prevent this from becoming a problem (hopefully). There might be months where work is tough, and we want to go out to eat more. Or maybe we have more people come over and spend a little extra on groceries. In either case, it prevents stressful situations and provides some margin in our budget.

Other Resources

Here are some additional resources you might find useful. Some of these directly address “pay yourself first,”, while others talk about budgeting on a general level.

Summary

Paying yourself first is often stated as being the golden rule of personal finance. And there is a good reason for that. It tends to limit our spending on unnecessary crap and increases how much we save or invest per month.

“Pay yourself first” has been tremendously helpful in paying off our credit card debt. I want this financial habit to continue as we pursue increasing our wealth and financial freedom.

Do you pay yourself first? What do you think about this idea?

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