Always Pay Yourself First
Learn how to set aside money for future investments, even if you are swimming in bad debt
Pop quiz: When you receive a paycheck, who do you pay first? If you’re like most Americans, you’re probably paying everyone else first—your rent/mortgage, groceries, utilities, car payment, insurance, etc. Then, once you’re done paying all those bills, you stick whatever you have left (if anything) into savings—that’s the classic “paying yourself last” scenario. Then you patiently await your next paycheck and repeat the process all over again. That’s the great American Rat Race.
But if you ever want to get out of the Rat Race, then I’m here to tell you you’re doing it wrong.
The philosophy of paying yourself first came from George Clason’s book, “The Richest Man in Babylon”, which was written nearly a century ago. And its message still holds true today, despite how the world has changed. In fact, Nasdaq named it the No. 1 proven way to save money.
People who choose to pay themselves first allocate money to the asset column of their balance sheet before they’ve paid their monthly expenses. Essentially, you set aside a specific amount of money right off the bat, and then live off what’s leftover. And that’s how wealth grows.
If you aren’t doing this now, have no fear—it’s never too late to ditch your bad habits. Learning to manage your money properly now with a “pay yourself first” mindset will ensure you have it to invest later.
How to pay yourself first
When you begin paying yourself first, it will feel totally backwards because you’ve been doing it wrong for decades. But trust me, it’s the only way to go. Robert and I have had many bookkeepers and accountants who have balked at our approach, because they too have grown accustomed to paying themselves last.
Each month, whether it made sense or not, we put aside a set sum of money into our asset column. We treated it just like an expense. In fact, we treated it as our most important expense. Even during times when my cash flow was less than my bills, I still paid myself first. And you can too. How?
First, don’t get into large debt positions that you have to pay for. Keep your expenses low. Build up assets first. Then buy the big house or nice car later.
Second, when you come up short, go ahead and let the pressure build — don’t dip into your savings or investments as a bailout. You see, poor people have poor habits. And one of those poor habits is dipping into savings to pay bills. Use the pressure to inspire your financial genius to come up with new ways of making more money, and then pay your bills with that. Bonus: You will have increased your ability to make more money and boosted your financial intelligence.
So let’s say you’re taking home about $4,000 a month. If you first pay yourself $500, then you have $3,500 left for living expenses. After one year’s time, you’ll have saved $6,000. You can even set this up automatically with your bank, to remove the temptation of spending the money.
But how can I save when I have debt?
Brace yourselves for this fact: Robert and I had about $400,000 of debt when we started our lives together in 1984. But by 1990 we were debt free. Here’s how we did it, and thus, here’s my advice for you:
Step 1: Immediately stop accruing bad debt. Stop adding to your credit card balances.
Step 2: Make a list of all the debt you owe (credit card, school loans, car loans, IOUs to people, your personal residence, etc.) so that everything is clearly organized and accounted for.
Step 3: Hire a bookkeeper so you can’t hide from the truth—he or she will keep meticulous records each month, so you always know where you stand (even if you don’t want to admit it).
Step 4: Robert and I decided that with every dollar that came into our household, we’d take a set percentage off the top and set it aside. Yes, this was the beginning of us paying ourselves first. We set up three piggy banks: one for savings, one for tithing or charity, and one for investing. We then set the percentage for each piggy bank at 10% each, for a total of 30% of all income we received. If we received $100, then $10 went into the savings bank, $10 into the charity bank and $10 into the investing bank. After we had paid ourselves first, we then figured out how to pay everyone else. This took a bit of work, calling and haggling, but in the end all the creditors were paid, everyone was happy, and we had money to invest with. We did this with every dollar we received. You don’t have to start off with 30%, but whatever percentage you choose, stick with it each month and increase when possible.
Step 5: Determine the order for paying off each debt by starting with the lowest and working toward paying that off. For all other debt, just pay the minimum amounts due each month. Once your first (lowest) debt is paid off, then work on the next debt (second lowest) and so on.
Step 6: Stay the course! Remember, you have to stick to this plan every month. If you say to yourself, “I’ll go off the plan just this month,” then you won’t form the habit and your debts will not go away.
What the ‘pay yourself first’ philosophy isn’t
Some people get the wrong idea when they hear the term, “Pay yourself first.” They actually hear, “Treat yourself first.” They think it means splurging on things, kind of like Donna and Tom’s “Treat. Yo. Self.” from Parks and Recreation. In this show, these two government workers buy whatever they want once a year.
That was not the purpose of paying ourselves. Far from it! Instead, the purpose was to make a conscious and purposeful contribution to our asset column so that we could invest our money and make it work for us.
This helped us develop the golden financial rule for us as a couple: Any money in the asset column stays in the asset column.
We follow this rule religiously to this day. We never move any of our money from our asset column into other areas (such as to pay expenses or to buy liabilities like cars and vacations). This has allowed us to build our asset column exponentially over the years.
For instance, I started investing by purchasing a small home in Portland, Oregon many years ago. By keeping the money earned from that investment in my asset column, I’ve been able to build from that foundation to now owning thousands of apartment units across the United States. All it took was discipline (and hard work!).
Buy assets to enjoy the finer things
This doesn’t mean we don’t enjoy the finer things in life. What it does mean is that if we want something nice for ourselves, if we want to treat ourselves, we find ways to make the money that doesn’t mean raiding our asset column. In short, we find assets that produce enough income through cash flow to cover our expenses and our luxuries.
Robert, for instance, loves his cars. A while back, he wanted to buy his dream Porsche. So, I challenged him to find an asset that would cover the cost of the car. Robert got to work and found a great mini storage investment that covered the cost of the car with monthly cash flow.
The upside was that not only did we have the car that Robert wanted, but we also grew our asset column. A few years later, the Porsche was paid for and we still had our mini-storage investment making us money each month. Eventually, we sold that mini-storage and rolled the money into a great apartment property.
The point is: We never subtract from our asset column to add to our liability column. Instead, we always keep our money in the asset column and add to it in order to afford the things we like.
It’s a win-win. We get to enjoy the finer things in life, and we grow our investments in the process. And that really makes it a golden rule.
Today, Robert and I are richer, not just because we have a lot of money—but richer from the experience and the lessons we learned digging our way out of debt. And while you’re working to get your personal finances under control, it’s a good time to start planning ahead for the real estate investments that’ll help you grow richer.
Source: Rich Dad