Pay Yourself First

Hello Young People, Pay yourself first! There, I said it. I know that lots of financial gurus advocate paying your debts off first, before you start investing anything. But, I am in the “pay yourself first” camp.

What Does Pay Yourself First Mean?

Pay yourself first means that each and every time you earn some money, you save and invest some money for you, more specifically…your future. This means, even before you pay the government, pay yourself first. The way to pay yourself prior to paying the government, is to focus on saving money in retirement accounts.

What To Do After You Pay Yourself First

After you pay yourself first, you use the rest of your money to pay your monthly living expenses, building level one of your emergency fund, and paying the minimum amount due on your debt.

After you’ve built your level one emergency fund, which is $3000, any extra money that you have left over after paying your monthly living expenses and the minimal payments due on your other debts should be used toward paying off your non-mortgage debt (NMD).

Once you have paid off all of your NMD, and your level one emergency fund is fully funded, you can start investing more for retirement, work on level two of your emergency fund (3 to 6 months of your living expenses), and save and invest for other long term goals.

While you have debt to pay off, do not view any money as discretionary.

You can budget small amounts toward wants, to be purchased as rewards for hitting various goals in your debt repayment and finances in general. But your main goal needs to be getting out of debt. (Excuse me while I briefly take this conversation into the topic of debt.)

Look, money is not good or bad. It’s just a tool. You can use money to pay for needs. Beyond your needs, you have choices. It can be used for wants. It can be used to pay for things and experiences. You can use it for yourself, your family, your friends, and to help others.

But, debt can be like slavery. You have no choice other than pay it. Enslaved by debt, you are prevented from using your money in other ways.

I encourage you to get out of debt, if you have any, and stay out of debt.

Why Some Say That You Should Pay Off Debt First Rather Than Pay Yourself First

The reason that some people say pay off your debts before you start paying yourself is because the debt will not go away, until you focus on it. In fact, the interest payment on debt is generally higher than you can make on most safe investments.

And while the interest is high, the minimum payments due will be low.

Why? Because the credit card companies and other lenders want you indebted to them for a long, long, time. The longer you are paying them, the more money they make, and those low payments can keep you on the hook for a crazy long time.

For example, according to Bankrate.com, to repay a $4,000 credit card debt at a 21.19% interest rate with the payment of $100/month, it would take approximately 71 monthe( 6 years and 9 months). In that time there would be $3000 in interest! That’s a total of $7000 paid to the credit card for the $4000 in charges! (Just thinking about that makes my head ache.)

So, those who say pay off your debt first are correct to be highly concerned about debt. However, I believe that the need to start saving for your retirement is just as important.

Why I Believe That You Should Pay Yourself First

First, I think that forming the habits of saving and investing is important. So, while I think that you should definitely focus on paying down your debt, especially if the interest that you are paying is higher than the interest that you are earning, I think that you should start the habit of investing from the very beginning, even if it is a minimal amount.

Secondly, because of the positive impact that time has on investments, I think that it is important to get the investment snowball rolling. Becoming debt free could take many years. So, rather than waiting until you are debt free to start investing, I prefer to start investing, even if at only a modest amount, from the beginning. That is actually what I did when paying off my student loans.

Third, you are the only person responsible for your future. So, you have to save and invest now for the future you.

Now, let me reiterate this…

If You Have High Interest Consumer Debt

If you have high interest consumer debt. You should lean into paying it off, but still put some money into saving and investing first.

If you wait until you have paid off all of your consumer debt to start saving for your future, you could find yourself pretty far along in life before you can start saving for retirement. Before you know it, retirement may be closing in on you and you may find yourself wondering how you’ll have money when you no longer have a job.

If you think that you’ll be able to live off social security, I hate to shock you. But, if you are lucky enough to be able to get any social security payments, it will not be enough money for the average person to live off. It was never meant to be. Social security is meant to be a supplement to whatever you have saved for yourself.

Save yourself, save for yourself. You work hard. You deserve to pay yourself first.

What Do I Mean By The Positive Impact of Time On Investments?

Time is a key ingredient in the most powerful recipe in growing wealth. That recipe for growing wealth? Compounding, such as compound interest and compound dividends.

What is Compounding? (It’s Key To Why You Should Pay Yourself First)

Compound interest or compound dividends is when the interest (or dividend) that your money earns then earns interest (or dividends).

So, in fewer words, …Your interest (or dividend) earns interest (or dividends).

Said another way…The initial interest (or dividend) is paid on the amount that you invest. But, if the interest (or dividend) is reinvested, along with the initial amount that you invested, with compound interest (or compound dividends), the future interest (or dividends) would be paid on the initial amount invested plus the previous interest (or dividends).

If You Don’t Believe Me When I Tell You How Important Compound Interest Is…

Hey, you don’t have to listen to me. Let me share the opinions of two very famous and successful people.

First, Albert Einstein allegedly called compound interest the eighth wonder of the world. I think that we would agree that he was a pretty bright fellow!

Second, Warren Buffet reportedly said, “My wealth has come from a combination of living in America, some lucky genes, and compound interest.”

So, Is Compound Interest Always Good For You?

Compound Interest can work for you or against you.

Just like you earn more money when you let your interest and dividends compound, you owe more money when the interest that you owe compounds.(Remember the credit card example that I gave earlier?)

For this reason, you need to pay off your consumer debt as quickly as possible.

But, that same power of compounding makes getting started with investing imperative, too.

(Of course, to get the real benefit of compounding, you need to keep investing money over a long period of time).

A young woman in her early 20s once asked me if she could become a millionaire by maxing out her Roth IRA account each year. The answer to that question is yes. According to Forbes Magazine, assuming a 10% return on your investments, it would take around 29 years with the current $6,500 per year maximum contribution.

Becoming a Roth IRA millionaire will take time.

Even though she wasn’t sure when she’d be able to contribute the annual maximum to her Roth IRA, the young woman’s response was “Game on!”

While that was not her only financial goal, she thought that the older her was worth the challenge. I applaud her!

How To Pay Yourself First

First, all saving and investing should be as automated as possible.

Where to put those savings? As I mentioned earlier, start by focusing on saving for your retirement. If your employer offers a retirement account, set up an automatic deduction from your paycheck to go into it.

How much should you pay yourself first? That depends on your current situation.

If you have debt other than a mortgage, I suggest that you start with as much as you can per month. I know that is not very specific. But, everybody’s situation and numbers are different.

Remember, if you are in a lot of debt, you have two missions: One is to pay off your non-mortgage debt (NMD) and the other is to get into the habit of saving for your retirement. Saving at least a small amount for retirement is just to get you into the habit of savings.

This plan may sound hard if you have high NMB. But, give it a try.

Saving for your future self is important. You are worth it.