You’re not alone.
Many people struggle to create and use a budget, or even hate the idea of using one. But here’s the good news.
You can work towards financial independence (FI) without a budget if you pay yourself first.
Yes, you’ve read a million times how budgeting is the bedrock of a financial plan, and I agree it is the ideal. But a budget won’t help you if you can’t seem to make yourself create one or if you quickly forget about it as soon as you do.
But paying yourself first gets you results in your financial life, with or without a budget.
Let’s dive in and see how this works.
What Does “Pay Yourself First” Mean?
Pay yourself first is when you prioritize setting aside money for your future self BEFORE you even think of spending it. As money flows into your life, you direct it towards savings and investment accounts before anything else. It means you come first in your financial life.
Like a furry squirrel, you collect acorns when the sun is shining and while there are plenty of acorns strewn across the forest floor. Instead of eating them now, you save them for later, hiding them from yourself. Then when winter descends and blankets the world in snow, you have your stash to keep you going in the cold and dark days.
The more you save, the more protection you have against adverse events in life.
Plus, the money you invest can grow and build your wealth. Unlike our squirrel friends, our acorns can multiply on their own (thanks to compound interest). But investment growth can’t happen until you first set the money aside for yourself.
Pay Yourself First to Build Financial Independence
Makes sense, right?
If financial independence is one of your top goals, putting money towards that goal first is the way to get it done. Getting “motivated” is not. Motivation only lasts so long and withers in the face of our latest desires.
If you use the default method of spending first, then seeing what’s left over for savings and investments, typically there’s not much left. It’s only human nature to spend what we have. But if we never see it, we are less apt to spend it.
Here are four more ways paying yourself first is the best thing you can do for your financial future.
1. Paying Yourself First Takes Decision-Making Out of The Process.
Using automation and setting up systems to manage your money reduces decision fatigue.
All the decisions we need to make each day burn up our cognitive fuel. As this article in Medical News Today states:
“Decision fatigue is the idea that after making many decisions, a person’s ability to make additional decisions becomes worse.”
Automation not only prevents decision fatigue, it also takes your irrational self out of the process. Because let’s be honest, if you had to decide between an expensive vacation and adding another $5,000 to your retirement fund, guess which one would win every time?
Automate, don’t decide.
2. Paying Yourself First Is a Healthy Money Habit with a Tangible Result.
So much of what we do in life are small incremental changes that are hard to see. But here, there’s a tangible, visible reward. You can see your progress and get the wonderful feeling of moving forward in your financial life.
Habits establish our identity, and this habit turns us into someone who has a shot at financial independence. As James Clear states:
“The key to building lasting habits is focusing on creating a new identity first. Your current behaviors are simply a reflection of your current identity. What you do now is a mirror image of the type of person you believe that you are (either consciously or subconsciously).”
By establishing paying yourself first as a habit, you now become the kind of person who invests in their future.
3. Paying Yourself First Has Positive Psychological Benefits.
Your money mindset changes for the positive, as your increasing wealth promotes an abundance mindset.
4. Paying Yourself First Avoids the Bane of Lifestyle Creep
Lifestyle creep happens when you fall into the default pattern of “the more you make, the more you spend.” The best way to interrupt this pattern is to save an automatic percentage of your increase instead every time you earn more money.
For example, if you get a 5% raise, add another 2.5% to your investment account. This way, you automatically contribute more to your future with every income increase.
It’s easy to find more things to spend money on. But with paying yourself first, you don’t see the money, so you don’t spend it.
Ok, enough said about why. Now let’s see how to do this.
Three Steps to Pay Yourself First
Step One—Decide on An Amount (Or Percent of Your Income)
To do this right, you need to know your financial goals. What are you trying to accomplish?
For most readers, it’s building up their retirement accounts, like Roth IRAs or 401(k)s, as that’s the way to build financial independence. But, if you have high-interest debt, paying off your stress-inducing debt may be a priority.
Come up with the amount you want to save or invest each month—either a number or a percent of your income. You’ll need to understand your expenses so you can come up with a reasonable number, but please don’t use this as an excuse to procrastinate.
If this part is overwhelming, then decide on a small amount, like $10 a month, and move on to the next step. You can adjust the amount later.
Getting started with something is the critical first step!
Step Two—Decide How to Fund the Amount from Step One
In the best-case scenario, you don’t need to make significant changes to fund the amount you decided on.
For example, if you’ve recently received a raise or found a higher-paying job, you could divert a chunk of that money towards paying yourself first before you get used to spending all of your new income.
But more likely, you’ll need to either spend less or earn more.
Spending less has been my default method due to early life experiences driving frugality deep into my brain. If you need ideas on saving money, check out my frugal living guide or read a quick guide on creative frugality to jumpstart your thinking.
The second way is to earn more. If you enjoy your work, consider working towards a promotion or higher-paying job and then putting a portion of any raises or bonuses you receive towards paying yourself first. Or you could start a side business and use part of your earnings towards your goals.
For best results, do a little of both!
Step Three—Decide on A Plan and Automate It
The goal is to automate everything and put a system in charge.
Here are some ideas:
- Fund an employer retirement plan.
For employees, this can be easy with a plan like a 401(k). Here, the money is deducted from your paycheck before you even see it, perfect for paying yourself first. For the self-employed, there are tax-deferred retirement options that you could be eligible for. Same as an employee, have the amount deducted from your “paycheck” or automate a transfer each month from your bank account to your retirement plan.
- Fund an IRA or a Roth IRA. For example, if you wanted to contribute the maximum to a Roth IRA (as of 2021), split the $6,000 yearly amount into $500 a month. Then have the money automatically deducted out of your checking account each month.
- Fund a Health Savings Account (HSA). This option is only available if you have a high deductible health care program. However, if you have the savings to pay the high deductibles, it can be an excellent way to save for health care costs. It’s a secret weapon for early retirement, as the “Mad Fientist” explains.
- Fund a savings account for either an emergency fund or to build general savings as a confidence booster. Yes, I know savings rates are low, and you lose money to inflation, but the peace of mind from holding cash is, as they say, priceless.
Employees can ask to have their direct deposit split between accounts. For example, I had my paycheck split between my checking account and a savings account. This meant that money automatically flowed to savings without my having to think about it—precisely what you want.
If direct deposit isn’t available, you could always have an amount automatically deducted from your checking account and transferred to your savings or investment account.
Pay Yourself First to Super Charge Your Journey to Financial Independence
In the journey to financial independence, the best way to build wealth is to pay yourself first.
The main purpose of budgeting is to carefully manage your money to increase the amount available for savings and investments. But if you hate budgeting or spending plans, simply fund your savings and investment accounts first before spending on anything else.
If this still feels intimidating, start small. Even $20 a month into savings or 1% of your salary into a retirement plan can get you moving forward.
When you pay yourself first, it sends a clear message to your brain that you, and therefore your life, take priority.