Monday, March 24, 2014
Pay Yourself First
The most basic principle in building wealth is spending less than you earn. Saving money is not encouraged by the Government, the media, the banks, or the spoiled little brat that lives somewhere inside all of us. If you do not decide where you want your money to go, there are plenty of people who are more than willing to make that decision for you. However if you ever want to reach financial freedom, you need to pay yourself first. Every month before you spend a penny on anything else, do two things with a predetermined portion of your money. If you are a Christian, pay God first. Give something without expectation of return. It is good for your soul. Then, pay yourself second. Put some percentage of your take home pay into savings. If you aren’t a Christian go ahead, follow the advice given by just about every personal finance author for the last one hundred years, pay yourself first. Then give something to charity. It is good for your soul. The initial savings goal is 10% of your take home pay every month. I will let you decide on how much you wish to give to charity. Start a “rainy day” fund in a bank or a money market fund. The goal here is six months cash reserve (six months take home, both salaries). It will take some time to reach this goal. Don’t beat yourselves up about this but keep putting a little something aside every month. When is the emergency fund sufficiently large to begin a fanatical effort to pay down your credit card debt? This is a matter of debate among personal finance authors. The low number is $1,000 in the emergency fund—then a full bore attack on your credit cards. The high number is eight months of living expenses before attacking high interest debt. It is your life. You need to make a reasoned decision based on your job security, controllable versus uncontrollable expenses, and the size of and interest rates on your unsecured debt. Once you have two to four months cash emergency fund in an insured money market fund or savings account and you have paid off your credit cards and other high interest debt then begin to save for a dream. For most young couples this will be money for a 20% down payment on their first home. For many older couples the big dream is a comfortable retirement. Automate the savings process. Here is how that works. Most of us have our paycheck electronically deposited to our checking account. When this happens have the bank automatically transfer a predetermined amount to an insured savings account or a money market fund. In your mind decide that money that goes into this account never comes out of that account for anything but emergencies until the balance reaches your “sleeping point.” Then additional funds above and beyond the sleeping point will only be spent on a predetermined dream or transferred to an investment account such as a Roth IRA. If your employer offers matching money with your 401 (k), for heaven’s sake, take the money and run. You simply can not beat an instantaneous 100% tax deferred return on an investment. Often employers offer 3% in matching money. This is a good way to begin saving for retirement. If you withhold 3% of your gross income before you ever see it, you will never miss it. You may have noticed there is an undertone to every suggestion in this article. Make all your decisions in advance. Consider these decisions an ironclad contract with yourself. As far as possible, automate the processes involved in implementing your plan. Decide, I will save X% of my take home pay by means of automated transfer of funds. First I will build an emergency fund of $Y. Then I will attack any debts with more than a Z% rate of interest. I would suggest any interest rate over 7% or 8% should be considered a high rate of interest. Once I have paid off my high interest debt, I will begin to save for a (fill in the blank). It is your life. How you choose to fill in the blanks is your decision. If you choose not to fill in the blanks, remember, someone else is always watching your money. One more suggestion; set yourself up for success by beginning with easily achievable small goals that are then increased incrementally until you achieve your ultimate goal. If 10% take home pay to savings seems overwhelming, start with 3% to be followed by a 1% monthly increase until your reach 10%.