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For many people, the pay-yourself-first budget is an indispensable tool that helps them live within their means, and it requires little maintenance to keep going. However, others may feel it’s overly restrictive and not flexible enough to respond to unexpected expenses. Read below to find out more about this budget and whether it’s right for you.
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What Is the Pay Yourself First Budget?
Also called “reverse” budgeting, the pay-yourself-first model flips the script on the more traditional approaches since it focuses first on your savings goals instead of your expenses. This isn’t to say it disregards essential expenses like paying for rent, utilities, or groceries – these are always factored in. Rather, the top line item of your budget will always go toward goal-based savings whether that’s an emergency fund, retirement, down payment for a home, or investments.
By focusing on “you” right from the start, this budget helps you save money and forces you to limit spending on non-essential items. Yes, for many people this means they’ll be more restricted on what they’re able to do with their money in the short-term, but by paying yourself first, you’re setting yourself up for success in the future.
Advantages of the Pay Yourself First Budget
- It’s easy to implement, especially if you automate your initial savings payments
- Great for people who have trouble saving money since any extra funds will be out of your bank account at the beginning of every month
- Doesn’t require a lot of detailed accounting or categorizing
Disadvantages of the Pay Yourself First Budget
- If you’re already on a tight budget or living paycheck to paycheck, you may not have enough wiggle room to truly commit to it
- Those with a lot of debt may be better off putting the majority of their extra funds toward this first before saving for long-term goals.
How To Make a “Pay Yourself First” Budget
Step 1: Assess your income and spending
All types of personal budgets require you to have an accurate picture of your income and regular expenses. To do this, review the past three to six months of your bank and credit card statements and input all this information into a spreadsheet or app to organize the data. If you don’t have a predictable monthly income, take an average over several months.
You’ll also need to know how much you spend in an average month and this should be broken down into your necessary expenses (what you need to live) and your discretionary expenses (anything you can live without). This can also be thought of as your needs versus your wants.
Step 2: Choose how much you’ll save each month
Since the pay-yourself-first model requires an upfront payment into your savings, this is the first amount to determine. There are a couple of ways to do this. After you’ve tallied up your regular expenses (needs and wants), you can simply subtract this number from your monthly income and whatever’s left over is what you’ll save. However, for some people, this simple equation (income minus expenses) will leave them with little to nothing each month and they’ll have to get creative in finding extra money for savings.
One approach is to use the 50/30/20 rule. This is a complete budgeting model, but the basic idea can be used for many aspects of personal finance like prioritizing saving money. This approach allocates 50% of your income to essential expenses (rent, utilities, groceries, transportation, insurance), 30% to discretionary expenses (dining out, entertainment, memberships, subscriptions, travel, hobbies), and 20% to savings and investing. You don’t need a detailed accounting since you can just use the percentages to figure out how much you should be saving. For instance, if your monthly take-home pay is $4,500 then you’d want to save 20% of that, or $900 each month.
Step 3: Make your savings goals
However much money you’ve allocated for savings, you’ll now subdivide into your different goal areas. This will usually include building an emergency savings account or contributing to a retirement fund first. After these two areas have been funded, you can then start saving money for other things like a new car or house.
Step 4: Track your progress and make adjustments
You’re probably not going to get everything right in the first month, and it will be necessary to make adjustments as you go along. For instance, if you get a raise at work, you should start putting more toward your long-term goals. Or, if you fully fund your emergency fund (three to six months of living expenses), you can now start putting that money toward another goal.
Pay Yourself First Budget Example
Let’s say you have a take-home monthly income of $4,000. If we use the 50/30/20 rule to determine how much should be saved, we come up with $800 a month. A budget using these numbers might look like this:
Pay yourself first: $800
- $500 to an emergency account
- $300 to a retirement account
- Once the emergency account is fully funded to $14,400 (six months of essential expenses), the $500/month starts going toward a down payment on a home
Essential expenses: $2,650
- Rent: $1,500
- Utilities: $200
- Groceries: $500
- Insurance: $200
- Car payment: $250
Discretionary expenses: $550
- Dining out: $230
- Entertainment: $100
- Hobbies: $70
- Subscription services: $50
- Gym membership: $100
Who Is the Pay Yourself First Budget Best For?
This budget is best for those who have a predictable income with enough margin that they aren’t stretching to make ends meet each month. It’s also an excellent tool for those who have a comfortable income but may struggle to save money or control their spending habits.
Does the Pay Yourself First Budget Really Work?
Yes. This simple budget works to help you meet your financial goal and spend less money. When you start each month by automatically transferring over a significant portion of your income to savings and long-term goals, you simply won’t have the option to overspend or purchase things impulsively. It’s a great way to quickly build up your savings while also ensuring you keep enough for your essential expenses.
What if I can’t afford to put 20% into savings?
It’s always better to start small and then ramp up as you go along. For many people, 20% will be an aspirational amount. Even if you only start with 5% that’s better than nothing and will let you get used to the process. After a few months, try bumping it up to 7% to see how that goes.
Is paying down debt considered a necessary expense or is it part of savings?
This depends on who you ask. Some people will tell you that making minimum debt payments should be included with your necessary expenses alongside rent and groceries, and it shouldn’t be a part of the initial savings. However, others will advise you to include any debt payments that go beyond your minimum as part of your savings goal, especially if they have a high interest rate.
Should I keep all the money I save in my bank account?
Any money you put away for savings should be kept in a high-yield savings account and most banks will offer this. Most traditional savings accounts only have around a 0.57% annual percentage yield (APY) whereas a high-yield account can go as high as 5%, so you’re growing your money while saving.
