One of the most fundamental rules of personal finance is to live within your means. Spending less than you earn is essential to creating your own financial self-sufficiency.
Of course, avoiding overspending is a challenge for many people, and the most common prescription for this problem is to make a budget. When budgets work they can be great, but for a lot of people, they’re hard to manage. Budgets are frequently compared with dieting, and with good reason: they’re both good for you and aren’t much fun.
There’s an alternative: paying yourself first is setting aside your savings as soon as you get your paycheck before you pay any bills, and instead of waiting to see if anything’s left at the end of the month.
While budgets work for some people, for many others, paying yourself first is a far superior approach. Here are a few reasons why it often beats budgeting as a proven way to live within your means.
Tedium versus Ease
How do you make a budget? Whether you’re using an app, a spreadsheet, or pencil and paper, budgeting begins with taking all your expenses over some period and putting them into different categories (groceries, clothing, rent/mortgage, transportation, etc.). Yes, some apps can categorize for you, but you still need to go through them and make sure the algorithm got it right. It’s often time-consuming, and too often, too many expenses go into the unhelpful “miscellaneous” category.
When you pay yourself first, you can start with a simple goal, like saving fifty dollars out of your current paycheck, and maybe one hundred dollars out of the next. (If you have to, it’s OK to start even smaller.) Once you have paid yourself, your essential expenses, like food, clothing, and the rent or mortgage, and then what you have left is available for discretionary expenses.
Pain versus Joy
Once you’ve categorized your expenses, a budget then makes you decide where you’re going to cut back your spending. Asking yourself, “What can I give up? What can I do without?” isn’t much fun. The goal of budgeting is to get or keep spending under control, and this often means cutting back in exactly the category that has provided the greatest sense of satisfaction. Starting by committing to deprivation reinforces the negative experience of saving more money.
Changing the focus to the savings side can make all the difference. If your goal is to save $50 out of the next paycheck, then for right now, that’s the only goal. Transfer that $50 to a separate bank account and keep it there. For that time around, that’s a success. You can increase the amount as you gain more confidence in your ability to keep some of your income. Instead of focusing on what you’re giving up, your focus is on what you keeping for yourself.
Guilt versus Accomplishment
Of course, unexpected expenses happen. Car or home repair, medical deductibles, or a lost cell phone can make you spend more in any one category that you budgeted for. For too many people, this variance from their plan feels like a failure, even if they’ve made up for it in other areas. The angel on one shoulder says, “Look how much you saved on dining out this month,” while the devil on the other scolds, “Yeah, and you spent it all when you dropped your phone into the sink!”
In fact, one reason a lot of people pay themselves first is to create a “not quite emergency” fund. This is money set aside for those annoying expenses that crop up unexpectedly but that don’t justify taking from your emergency fund. Yes, you may need to take it out again at some point in the next year or two, but having money set aside for this purpose helps avoid the feeling of guilt when one of those inevitable expenses comes up.
There’s no getting around the fact that money can be a very emotional subject. If you focus instead on your saving rather than your spending, it’s easier to notice your improvement and be motivated to continue. When Ken started paying himself first, one of his goals was to start an emergency fund. What he didn’t expect was how it would make him feel: “I started with nothing, and the first time I saw that my savings had reached $1,000, I felt like a king!”
Failure versus Success
When Ken would speak to groups about personal finance, he often asked how many in his audience had ever tried to follow a budget. Most of the time, about half the people in the room raised their hands. Half of those hands went back down when he asked how many were successful with their budgets. (And only about one person in 20 said they enjoyed budgeting.)
If only about half of people even try to make a budget, only a quarter succeed, and only five percent enjoy it, it makes sense to see if there’s an alternative. Paying yourself first simplifies the process: get your paycheck, set your savings aside, pay for the necessities, and give yourself permission to spend the rest.
If Budgeting has worked for you and you enjoy it, by all means, continue, but if you are one of the many people who has repeatedly failed in coming up with a budget or if you have never tried to reduce your expenses, we encourage you to try to pay yourself first instead.
Complexity versus Simplicity
The traditional budget is an ongoing exercise in accounting. The budgeter sets their goal in each category of expense and then has to measure their performance against that goal, with all the guilt that can sometimes bring. It’s much easier to stick to a simpler process that requires one simple act on payday: set a pre-determined amount of money aside and don’t spend it. As long as that amount is eventually big enough, you can use this simple system to meet any number of financial goals.
Of course, the amount you save should line up with your objectives and your personal circumstances. When it does, paying yourself first is a much simpler process than budgeting is, and all you need to do to succeed is to set aside the money in the first place and not spend it on anything other than its intended purpose. That could be retirement, a new car, a down payment for a house, a vacation, or a hundred other things.
These are goals that usually take multiple pay periods—often dozens or hundreds of them—to achieve. Your financial advisor can help you identify the right amount to set aside, and the best place to save or invest it, for the goals that are important to you. (Plans like 401(k)s are often ideal places to pay yourself first.)
Finally, remember it’s OK to start small. If you didn’t save anything out of your last paycheck, saving even a small amount out of the next one is a step in the right direction. You can always increase that with the following paycheck, and once you start, you may find it’s easier, and you can save a lot more than you ever thought possible.