Budgets are usually built around expenses like rent, groceries, and utilities, as well as discretionary expenditures such as entertainment. Pay-yourself first flips this approach and prioritizes using your income to save before anything else.
Although reverse budgeting is effective, not everyone will find it useful.
What is meant by ‘paying yourself first?’
Pay yourself first is a budgeting strategy that reverses the usual focus on fixed and variable costs. Instead, you plan your expenses around saving goals such as retirement. Savings are prioritized, but not to the detriment of other costs such as housing, utilities, and insurance.
Budgeting: How to ‘pay yourself before others’
Create your reverse budget by following these simple steps.
Step 1: Determine your current spending
You’ll need to plan if you want this budget to be successful. You can start by looking at your credit card and bank statements and calculating how much you can afford to save every month.
Step 2: Calculate how much you will pay yourself
Use the method to determine a realistic figure. This method allows 20% of monthly income for savings and debt repayment. 50% goes to necessities, and 30% is allocated to wants. If you earn $3,400 per month, for instance, you will reserve $680 to pay off debt and save $1700 for necessities and $1020 for wants.
Step 3: Set your savings goals
List your short-term goals and long-term goals. Prioritize saving for retirement and creating an emergency fund before pursuing other purposes like a new house, appliances, or travel.
Choose a few goals to start with or contribute a little to them all. Use the 50/30/20 rule to determine how much money you will need to save each month to achieve your goals.
Let’s say you earn $3,400 per month and want to set aside $150 each month for an emergency fund. You also want to put $200 away for retirement and $100 towards a motorcycle. Put aside $450, and then use the rest of $2,950 to pay for other expenses, like rent, groceries, bills, loans, etc.
Step 4: Adjust as necessary
In an ideal world, you would have enough income to meet your needs, wants, and goals. If you are still short of funds, find ways to cut back. You might want to focus on a single savings goal and ways to reduce expenses in your categories of needs and desires or do all three. You could also consider a side job to supplement your income.
Pros and cons of paying yourself before others
- Low maintenance. Pay-yourself-first budgeting is less work than other methods, like zero-based budgeting. This method does not require you to categorize every expense or keep a detailed account of your spending.
- Zoom out Reverse Budgeting helps you focus on the big picture. People tend to save more money and spend the rest on items they value or need.
- You can automate it. Set up contributions using your pre-tax income if you have a Superannuation Account. You can use an app or log in to your bank’s website to set up automatic transfers from your daily account to your savings account. You can even create separate accounts to save for different goals.
You can also find out more about the Cons.
- Savings over other goals is not always in your financial best interest. If you have hazardous debt, such as high-interest credit cards, we recommend paying it off before saving for a vacation or new car.
Ready set, save
Suppose you want a budgeting system that is more hands-off or don’t like the idea of budgeting, paying yourself first can be a good option. Automate your savings to make it easier.
If you want more structure, try a budgeting system that involves more detail, such as the envelope method, which allocates your income to all of your expenses.