Reverse the Way You Budget by Paying Yourself First
Many people approach budgeting in this fashion: Pay bills, spend a little, and any money that’s left goes in savings.
But those leftover crumbs aren’t often enough. Not prioritizing saving may be the reason nearly a quarter (23%) of Americans don’t have any money in savings, according to a recent financial literacy survey conducted by The Penny Hoarder. Of those surveyed, about 40% reported having less than $1,000 saved up.
One way to save more for the future is to prioritize saving over everything else when creating your budget. Some refer to this approach as reverse budgeting. Others call it the “pay yourself first” strategy. However you think of it, focusing on saving first can pull you from the rut of not saving at all.
Pay Yourself First: the Why and How To
Mark Charnet, founder and CEO of American Prosperity Group in Pompton Plains, New Jersey, suggests saving about 10% of your net income — the money you receive after taxes, healthcare premiums and 401(k) contributions are taken out — each time you get paid.
If you can’t afford to put away 10%, start smaller. The bills never stop, and it’s not like you can tell your credit card company you can’t pay this month because you’re working on your emergency fund. We get it.
How you divvy up your savings depends on your individual needs, but Charnet said you should focus on saving for emergencies, retirement and big upcoming purchases, like a down payment on a house. And yes, that’s retirement savings in addition to those 401(k) contributions that are automatically deducted from your paycheck.
If you need to buy a car in the near future, divert a larger amount of cash toward that goal. If you’re aggressively saving for an early retirement, funnel money to max out your individual retirement account. Charnet said once you’ve built up an emergency fund with six months worth of income, you can let that money sit and focus on the other priorities.
Automating saving can help you set aside money without having to think about it. Adjust your direct deposit at work so a percentage of your check automatically goes to savings. Or schedule automatic transfers from your checking account right after you’re paid.
If you’re unsure of the best way to save money for the future, Charnet recommends talking to a financial adviser.
“[Those just starting to save] should not feel embarrassed or make the assumption that [they’re] too small of a fish for a financial adviser,” he said. “That is absolutely not true.”
After your savings are deducted from your income, you can focus your budget on paying bills, covering necessary expenses and discretionary spending.
You may find you have less money for extras — like entertainment or eating out — but if you pay yourself first you’ll be in a better financial situation to face the future, instead of scrambling to come up with money when you truly need it.
Nicole Dow is a senior writer at The Penny Hoarder.