The pay yourself first strategy - Episode 73

Financial Autonomy

Episode 73 - The pay yourself first strategy

Have trouble building up a nest egg? Struggling to build up enough cash to start investing? Hate the idea of a detailed budget?

If you answered yes to any of these questions, then the Pay Yourself First strategy could be for you.

The idea of Pay Yourself First is not new – Google tells me the term was first used all the way back in the 1920’s by an American publisher. But it’s even easier to apply today thanks to the advent of internet banking.

Let’s get straight to it. The idea with Pay Yourself First is that you set aside money in a separate bank account on the day you get paid, and then live off what’s left.

The opposite would be to save whatever is left in your bank account at the end of each fortnight.

It’s essentially the precursor to the bucket strategy, which is where you have separate bank accounts for bills, savings etc.

Pay Yourself First then is a form of budgeting, potentially without the need to do the detailed work on how much you spend on coffee or shoes.

You’re effectively hiding money from yourself.

Where this strategy has become really useable is through the use of automated transfers via internet banking. Automating the transfers to your seperate bank accounts is enormously powerful because it takes away any will-power issues.

So let’s work through the strategy in practice.

You have your normal bank account that your pay goes into, and that your living costs come out of.

Let’s say you get paid fortnightly on a Thursday.

You would set up your internet banking to automatically transfer a set amount out of your bank account every second Thursday, to correspond with your pay day, and put it into a separate bank account. Ideally, I’d suggest two bank accounts, one for bills and one for savings. So for instance you might have $500 go automatically across to your bills account, and $200 go across to your savings account.

Whatever is left in your account is what you have to live off until next pay day. If you get to the last day and your bank balance is 5 cents, then it’s Vegemite sandwiches for you.

Of course you can fine tune the amounts transferred so that you get a situation where you do have enough money to live off, and the bills account is getting enough money thrown in to actually cover the bills you need to pay. But this is where the beauty of modern day internet banking comes in – it’s easy to adjust your automatic transfers.

I can’t emphasise enough how important automation is to the success of this strategy. The central element of this strategy is that your savings happen first, then you spend. You’re purposefully putting your future well-being and security ahead of your immediate consumption. This is what the original instigator meant – you’re paying yourself, by putting money aside for savings, before paying everyone else for your food, clothing etc.

Australia’s superannuation system is a form of Pay Yourself First if you think about it. Money comes out of your pay without you having to do anything, and is set aside for your eventual retirement.

Another useful aspect of the Pay Yourself First strategy is that it can be a way to avoid lifestyle inflation as your income grows. It’s tempting as you progress the career ladder to feel that your increased importance demands a matching BMW, or spending $15 per day on lunch instead of bringing in leftovers from home. Instead, you could simply increase your automatic transfers, so that your new increased income flows to savings and ultimately investment. This accelerates your progress in gaining choice in life, which is of course what we’re all about here at Financial Autonomy.

Another practical way that you could apply Pay Yourself First is for households with two incomes – either a couple or someone with a side hustle.

Perhaps you could live off one income, and have all of the second income go to savings and investment.

Pay Yourself First is forcing some frugality on what you spend. But that frugality need not be extreme – what you set your automatic transfers to is of course entirely at your discretion.

It certainly provides a practical framework in which to manage your money and ensure that you are building your financial resources.

Well that’s it for this week. If you’re not already receiving our monthly email update Gaining Choice, be sure to visit financialautonomy.com.au and register for that – there’s a link at the bottom of every page. That will keep you informed of all the goings on in the Financial Autonomy world in one single monthly email.