Practical: Pay Yourself First


Personal finance writing is full of the saying pay yourself first.  This made sense to me theoretically since you need to save, to build wealth.  However, from a practical sense I didn’t know what that meant: How exactly do I pay myself before I pay a bill?

After further inspection, I came to the conclusion that sticking to a budget is a way to pay yourself first.  The idea of a budget is to set an upper limit, the most you will spend for a time period.  The complement of the budget is the minimum saving you will accrue in that period.  In this sense, the budget allows you to pay yourself, with the remainder.

Finally after deliberation and a moment of eureka, I came to the conclusion that you could rearrange your bank accounts so that the only cash flow inlet your expense account sees is the budget.

http://adventuresinmissingthepoint.files.wordpress.com/2011/03/cash-flow.png?w=455&h=305

This flow ensures that you invest a minimum amount, which is the mathematical complement of the budget.  This is a way to ensure that you pay yourself first, at least as I understand the statement.

My pay goes into a high interest savings account, which then gets separated into investing and an expense budget.  With the investment income going to expenses, my flowchart has a Rich Dad, Poor Dad influence.  The arrow doesn’t necessarily need to go there, depending on personal interests.

For setting budgets, my personal favorite book on the topic is Your Money or Your Life.  I like that book because it provides a rational way to set up a budget and ensure that you are not over nor under, on spending.  The method is subject to change, scale, and variation, not a one time recipe.

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1 Response so far »

  1. 1

    Rooster said,

    Not sure if this was intentional but I like that the Investment box is the largest. To further develop that visual, I would leave savings small (only containing a fully liquid “safety net”) and make checking nil (on average it should have a zero balance, meaning it is merely a fund where all known inflows should equal outflows).

    Your system will ensure limited discretionary spending, which often equates to haste/waste. I’m going to think about this more and then change my direct deposit is routing. As is, my system (labor inc -> checking) allows for extra cash to appear as being “under budget” (aka sub-optimal savings).

    Nice work!


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