The #1 Rule of Personal Finance

The #1 Rule of Personal Finance

If look at personal finance articles there are all kinds of rules to pay down debt, budget, buying a house, etc. However, all of those rules pale in comparison to the #1 rule of personal finance.

That rule is:

PAY YOURSELF FIRST!!!

What Does Pay Yourself First Mean?

So now you know the rule, but you may not know how to carry it out. What does it mean? Does it mean you physically take your paycheck and give yourself some money? In some respects the answer is yes!!!

The primary way of paying yourself first is for you to contribute to investments for retirement. That could mean a couple of things:

  1. It could mean contributions to retirement plan offered by your employer. Those retirement plans could be a 401k, 403b, or 457 depending on your employer. Sometimes those plans are pre-tax or after tax. The primary difference is when you pay the taxes. For example, if you have a traditional 401k you will have money taken out of your paycheck that is pre-tax. In other words, it is not subject to any taxes until you take it out to use it (typically when you reach retirement age). Then, depending on your tax bracket you will pay taxes on what you take out.  There is also a post-tax option known as a Roth 401k. What happens here is that you pay the taxes up front and then the contributions are taken out from your normal paycheck. The advantage of this plan is that those contributions then grow TAX-FREE for the rest of your life. You never have to pay taxes again!!!
  2. It could mean you contribute to a retirement account of your own. Again, there are typically two options. You have a traditional IRA and you have a Roth IRA. You could have your paycheck deposited into a checking or savings account and then automatically have that money moved to your IRA or Roth IRA. The difference between the two is one grows tax-deferred and the other grows tax-free. There are advantages and disadvantages to both. The point of either way is that you are saving first and spending second.
  3. It could be a combination of both of above and additionally your own investment account. You could set it up where you have a work retirement plan, an individual retirement account, and a separate investment account where you invest in stocks, bonds, gold, real estate, etc. There are different ways to do it, but you could have all three, but the point is that you are saving FIRST and spending SECOND!
  4. Finally, paying yourself first could mean that you put money away in an emergency fund. Everyone should have an emergency fund. Your emergency fund could be a savings or checking account. I recommend that you make it an account that it might take a few days to get at it. We have an emergency fund. Most Americans couldn’t even handle a small emergency of $400. Having a little cash on hand is a good thing. But it should only be for TRUE emergencies (vacations don’t count).

The point of all of these is that you are saving first and not spending.

What If You Have Debt?

There are some financial gurus who will disagree with me on this. For example, Dave Ramsey advocates that you pay off ALL of your debt (except the mortgage) before you start investing.

I disagree.

Dave’s plan can be great for getting out of debt, but learning how to save is also important. By getting in the habit of saving right away we get used to not having that money. It becomes automatic. It becomes something we don’t think about.

Don’t get me wrong I think you should pay off as much debt as you can. However, I still think the #1 rule is paying yourself first.

How Much Do You Pay Yourself?

Well, this question is a conundrum. How much should I pay myself 5%? 10%? 15%?

The answer to that depends.

If you are drowning in debt and have access to a 401k plan I would encourage you to contribute your salary up to the amount of a company match. For example, many companies, if they have retirement plans, will offer a match to your salary. If you contribute 5% then they contribute 5% or 10% or 2% or whatever. I think you should contribute up to the match because the match is FREE MONEY!!! Get that money.

Then use the rest of your money to pay down debt, save for a sufficient emergency, etc.

Once those two things are done (paying down debt and emergency fund) then kick in even more savings. Ramp it up. Maybe you can even get up to savings rates of 15, 20, even 50% or more.

The more money you save the faster trip you get to financial independence.

I would tell you to save as much as you can and as fast you can. The basic minimum I think is to contribute 15% of your income to retirement. However, it might be a little less to start, but once the debt is gone it should be as much as you can.

How Do You Pay Yourself First?

The easiest way to do it is to make it automatic. For example, I am required by my job to basically contribute 10% of my salary to a retirement plan. In addition, I contribute to another tax-deferred plan. All of these  contributions I filled out a form and then they just took it out of my paycheck. it is automatic and I don’t miss it.

You can also physically transfer the money as well. The problem with this is that you have to be disciplined to do so. You have to physically tell your money where to go. For example, you have to log into your account, determine an amount to transfer to another account and click the button to do so.

I prefer it to be automatic. I set up a date/time and it does it. I can change it if I want too but make it automatic.

The Bottom Line: I don’t care how you do it, but you should PAY YOURSELF FIRST. Ideally this would be automatic deductions from your paycheck into a retirement plan, but circumstances can differ and it could be a combination of things. However, paying yourself first allows you to build your saving muscle, encourages you to have more money for the future, and reduces your risk as you get older. Pay yourself first before anything. If that means you can’t afford that new outfit, car, whatever, so be it. Paying yourself first is more important.

 

 

4 thoughts on “The #1 Rule of Personal Finance

  1. I am a huge fan of getting the match. So if offered it’s definitely hard to turn down free money to pay off debt.

    Although I normally try to run the numbers to make sure it makes sense.

    If you’re getting a 1% match I normally encourage paying off the credit card debt since a 19% interest rate is definitely going to hurt more than the 1% free match with an 8% return on investment from the stock market 🙂

    1. I can certainly understand that. BUt because we have such a personal savings crisis in this country to me it would be great if we could mandate savings in some way shape or form. If you are offered a retirement plan at your employer I would argue you should automatically be enrolled. The myRA program rolled out by Obama should be compulsory for people to some small extent and then go with paying off debt. Luckily, I also don’t have credit card debt at 19% interest. Well, now I don’t because I have finally been reimbursed for medical expenses from South Africa.

        1. That would be awesome if that could happen. I would even like to do the TSP. Although my choices aren’t bad. Like you I could’ve gotten a pension, but I chose to not enroll it. I didn’t think I would be here as long as I am. C’est la vie. The good thing I can leave a legacy for my family (assuming we have kids….let’s hope).

Leave a Reply