What 'pay yourself first' really means

'Paying yourself first' is a fundamental idea that includes putting your future finances first. This article gives useful insight on how to put money aside to reach your long-term goals.

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Pay yourself first.

It's a snappy little phrase that's used all the time in personal finance books and articles. I first heard it on radio ads advertising "get out of debt quick" and "get rich quick" schemes.

It sounds nice and impressive, but what does it actually mean?

When you "pay yourself," does it mean using that money for the finer things in life? Does it mean paying off bills? Does it mean investing?

When you do it "first," does that mean you ignore debts? Do you ignore your bills? Do you ignore your personal responsibilities?

And how do you "pay yourself," anyway?

Those 3 little words can dredge up a lot of misunderstanding. Let's break them down a little and see what's really going on.

Paying yourself

Let's tackle the first part of the phrase first. When it talks about "paying yourself," it simply means that you're putting aside money for your long-term goals. That's it.

When money comes into your life—a paycheck from work, an unexpected windfall, or something else—our first tendency is to use that money to put out the fires in our life. The bills that are due shortly get paid, for starters, and we make sure that we have enough cash to buy food and other supplies for the next few weeks. Once those necessities are taken care of, though, it's extremely tempting to look at that remaining money through the lens of our short-term desires.

Let's go out on the town! Let's buy some clay pigeons and have some fun at the shooting range! Let's buy a new board game! Let's go out to eat! Let's buy a phone upgrade! You get the idea.

When we see money just sitting there and we know that our fundamental needs are covered, it becomes really, really tempting to use that money for those fun things that are shouting out at us.

The thing is, that's not really "paying yourself." When you spend money on short-term fun things, that money just disappears. It goes out of your life.

The idea of "paying yourself" is that the money goes toward a long-term goal. It stays in your life in some fashion.

Let's say you "pay yourself" by making a big extra payment on a debt. That debt will get paid off months earlier, which means that you'll actually get the money back when that debt is gone. That ends up feeling like "getting paid" when a debt that you thought would stick around until November is now gone in March. At the same time, paying off a debt early means you're going to be paying less interest on that debt. If you pay off your credit card in March instead of September, that's 6 months of finance charges that you're not going to be dinged with. So, each month, it's like you're getting "paid" because you're not losing that money to the debt you owe or the interest on that debt.

A similar thing is true for all of your savings goals—saving for a down payment, saving for a car, saving for retirement, and so on. When you put that money aside for those goals, that money isn't disappearing out of your life for good. Instead, it goes into hiding, only to reappear when you need it for that big goal.

If you "pay yourself" by putting aside money for a house down payment, that money comes back in a few years when you're ready to buy a house. It's earned some interest, too, and it's probably going to keep you from having private mortgage insurance (PMI) on that mortgage. You were "paid" by the money you put aside earlier, and that money is covering your down payment.

If you "pay yourself" by putting aside money for retirement, that money comes back at some point down the road when you do retire. You're now getting "paid" by the money you put aside when you were younger, and that money is helping you survive in retirement.

When you pay yourself, all you're doing is putting aside that money for big things in the future rather than just paying today's bills and having fun.

First

The "first" part of the sentence is just what it sounds like: you do it first, before anything else.

This means that you "pay yourself" by putting aside money for long-term goals "first" before you take care of your bills and other things.

This does not mean that you stop paying your bills. It does not mean that you stop making minimum payments on your debts. It does not mean that you stop doing anything fun whatsoever.

What it means is that you leave yourself a somewhat smaller pool of money with which to pay your bills and have fun.

Let's say Jim brings home a paycheck of $400 a week. With that check, he normally pays his bills and puts some money aside for rent and for basic food, which adds up to about $300 of that $400 check. With the remaining $100, Jim has fun. He buys some steaks to cook on the grill. He pays his cable bill. He puts gas in his car. He goes to a baseball game. You get the idea.

Now, let's say Jim commits to "paying himself first." He decides to start putting $50 a week into his retirement plan at work, so now he's bringing home just $350 a week. He's paying himself first because that money is going away toward his long-term goal before anything else.

At this point, Jim has some options. He typically has $300 in bills he has to cover in a week, and that leaves him with just $50 to have fun with. It now takes 2 weeks of that "fun money" to cover the cable bill instead of just one. He's going to have to make some choices.

However, there's still enough left behind for Jim to cover his bills and have some fun. He just has to prioritize in a way that he hasn't had to do recently.

That's where frugality comes in.

'Pay yourself first' implies smart frugality

In Jim's story, if he decides to start paying himself first at the rate of $50 a week, he's going to have to figure out how to get the most out of $350 a week instead of the $400 he used to have, and that can be a challenge. Rent isn't getting any cheaper, nor is the cost of food. Some tough choices are going to have to be made.

At a glance, many will assume that this means less enjoyment for Jim. Obviously, the thinking goes, the part that will have to go away is the "fun" part: the nonessentials, things like entertainment and hobby spending.

If you look a little deeper, though, Jim can find creative ways to make cuts across the board.

He can call up his credit card company and ask for a rate reduction, or look for a balance transfer so that his monthly credit card bill is lower.

He can shop around for a new cell phone plan that's cheaper per month.

He can cut the cord by cancelling his cable bill and replacing it with some mix of free over-the-air network television, Netflix, Sling, and/or other services and drastically trim his spending on television programming.

He can commit to buying store brands rather than name-brand items.

He can start wearing warm clothes around his apartment in the winter and keep the heat a little lower so the energy bill isn't so high.

He can ride a bike to work on nice days instead of driving there, saving on gas and auto maintenance while getting some exercise.

He might look for a cheaper apartment, or one so close to work that he can sell his car, or he might consider seeing if his brother wants to split an apartment with him.

There are many, many, many things Jim could do that wouldn't have to interfere with the "fun" parts of his life at all. Of course, cutting back on those "fun" bits is a pretty easy way to make it work, too. The point is, it doesn't have to be misery.

The payoff

The payoff of "paying yourself first" is that when the big things in life come up, as they inevitably will, you find that you actually already have the money to handle it.

If you've been paying yourself first to prepare for a car replacement, when you decide to buy, you already have the cash in hand. No car loans, no hoping for a good interest rate, nothing—you just write a check for most of or all of the cost.

If you've been paying yourself first to prepare for a house down payment, when you decide to buy, you're ready to go with that big down payment. No PMI, no inflated interest rates—you're ready to go.

If you've been paying yourself first to prepare for retirement, when you decide to retire, you have money sitting there that can supplement your Social Security. That means a lot less scrimping and saving every month.

If you've been paying yourself first to prepare for an unexpected emergency, when something does go awry, it's not panic time. It's not time to put a huge balance on the credit card. It's time to calmly sigh, transfer some money back to your checking account, and just deal with it.

That's what paying yourself first really looks like, and it's pretty sweet.

Consider paying yourself first for the big goals in life. Pay yourself first to start saving for retirement. Pay yourself first to start building an emergency fund. Whatever your goal is, pay yourself first. You'll be glad you did.

Topics:
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Article copyright 2018 by The Simple Dollar. Reprinted from the October 5, 2018 issue with permission from The Simple Dollar.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third-party provider of the reprint permission and Fidelity Investments are independent entities and are not legally affiliated.

Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.

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