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There is perhaps no single piece of financial advice more frequently repeated than “pay yourself first.” And with good reason. It’s tough to grow savings if you prioritize all your spending needs and wants ahead of putting money away. While some of us fully intend to stash whatever is left at the end of each month, too often that leaves nothing to save.
This tendency to spend everything we earn is something governments understand well.That’s why they make sure they get their share—income taxes—before you even set eyes on your paycheque. Saving with the “pay yourself first” method follows the same principle. And this step-by-step guide shows you how to do it.
Step 1: Zero in on your savings goals
It’s easier to commit to paying yourself first when you know the purpose of your savings. Are you building an emergency fund? Saving for a down payment on a house? Are you hoping to pay for a wedding? Or fund your retirement?
Perhaps you are saving for all of these goals, or different ones. The important thing is to understand why you are saving and to set aside these funds outside of your day-to-day chequing account, which should be reserved for bill payments and other spending money. Research by behavioural economists has shown that this act of “labelling” money for a specific purpose makes it easier to save because it creates a psychological hurdle to spending the money on other things.
Step 2: Determine how much you can save
This is perhaps the most challenging part of the pay-yourself-first process because you need to make sure you won’t end up in overdraft. There’s no sense setting aside a set amount in savings at the beginning of the month if it means you’ll run out money to pay for necessities such as groceries, rent or utilities before the month is over.
Here’s how to figure out how much you can realistically save:
- Write down your average monthly take home pay.
- Subtract the average monthly cost of all your needs, including shelter, food, electricity/heat, phone, transportation, etc. (Note that purchases such as clothing and shoes are only “needs” if you are replacing items because they are worn out or your size has changed; otherwise they are “wants” and should not be included in this part of the calculation.)
- This leftover amount is called your discretionary income—meaning you can choose to save (or spend) as much of this money as you like.
Say you have $800 each month in discretionary income. You might decide to allocate $300 for spending on wants (like fast food or restaurant meals, entertainment or clothing) and $500 to savings. Obviously, the more you dedicate to your savings each month, the faster you will reach your goals.
Step 3: Earmark savings for each goal
Now that you know how much you can afford to save each month, you’re ready to decide how much money to direct to each of your savings goals. If, for example, you are planning a wedding for next year, you might choose to devote the majority of your earmarked savings to that purpose—at least until you have enough to fund the event. Once you reach that goal, perhaps you’ll decide to put half of those monthly savings toward retirement, and the other half into your emergency fund. Or perhaps you’ll set your sights on a home renovation, or a special trip.