Pay Yourself First - A Small Step in the Right Direction

You've undoubtedly heard the phrase "pay yourself first" somewhere along the way in your travels. You might vaguely recall hearing this valuable nugget of financial wisdom from someone you know or maybe you read it somewhere in a book or online - but what does it really mean?

As the term implies, to pay yourself first literally means just that, putting yourself at the very top of the list of things to pay. The first thing to come out of your pay should be a payment to yourself. A pre-determined percentage of your income should go straight into an RRSP, tax free savings account or any other savings or investment vehicle you have set up.

How much you put away doesn't matter - what does matter is that you put away something and start as soon as possible. Thanks to the wondrous power of compound interest even the smallest contributions over a long period of time can grow into a very substantial nest egg by the time you reach retirement age.

Pay yourself first is one of the golden rules for builidng personal wealth. It's a proven strategy that has helped make alot of people rich. Incredibly, most of us are not doing it, myself included until a few years ago. Thanks to David Bach's book Start Late, Finish Rich I now know that there's still hope...even for late starters like me.

If 'pay yourself first' really works then why isn't everyone doing it?

Good question! One reason could be because most of us have learned that bills come first. Things like your mortgage, car payments, groceries and the phone bill take priority and always get paid before anything else. Whatever's left over is used to pay for everything else. Inevitably all the money gets spent on other stuff and usually leaves you with no money left over for savings. Therein lies the problem.

The other problem with living this way is that your just keeping your head above water. As long as your lifestyle remains the same you'lll be treading water and keeping afloat financially. Unfortunately, this also means you have virtually no chance of ever getting ahead financially... unless of course you win the lottery. Furthermore, any sudden lifestyle changes such as a large purchase or loss of income will make your already precarious situation even worse and you will be forced into debt.

Ready for the good news? Even if you always find yourself running out of money before the month's end it is still possible to pay yourself first. The key is to make it automatic and as painless as possible (another David Bach concept).

Why it's important to pay yourself first - starting today!

Right now when you get paid, who gets paid first? Give yourself a pat on the back if you guessed the tax man. Why is that? Because, prior to 1943 taxes were not automatically deducted from workers pay checks like they are today. People got their cash and paid their taxes later. This was a problem, people weren't saving enough money to pay their taxes and wound up owing the government.

That's when the government got smart and started automatically deducting taxes from our pay checks. Now our taxes get paid and we don't miss the money because it was never ours to begin with.

Hmm, Maybe they were onto something there!

Like the Government, you can make sure you are paid first by automatically deducting from your pay check or bank account. Take it off the top and the money you intended to save gets saved. Bottom line - no over-spending, no unexpected expenses and no more cheating yourself out of savings. As an added bonus you can save yourself even more money by contributing to a tax deductible retirement account such as a RRSP or 401(k).

Here's a scenario to further illustrate my point about why its important to pay yourself first now instead of later:

*Assuming a growth rate of 10% til age 65.

• Janie is 20 years old and contributes $200 a month to her RRSP
• George is 40 years old and contributes $800 a month to his RRSP

- By age 65 Janie will have contributed a total of $108,000, the total value of her investment will be worth a whopping $2,096,500.34.

- By age 65 George will have contributed a total of $240,000, the total value of his investment will be worth $1,061,466.72.

How to pay yourself first

Automating the process of paying yourself first is simple, the only real challenge is actually finding the money to save. You can't commit too much money to savings afterall you still have bills to pay. A little creativity may be in order. Remember, the amount you save is not important - just save whatever you can no matter how small the amount - you can work on increasing it later when your circumstances change.

Now for the easy part - making it automatic. Here are two examples of how you can pay yourself first via direct deposit:

• Setup a direct deposit into a high interest or tax free savings account - This is ideal for short term savings goals like saving up for a major purchase like a vacation getaway or paying for home renovations.

• Enroll in your company's group retirement plan - Take advantage of any matching contributions your employer offers and watch the magic of compound interest at work as you build your retirement nest egg.

You could also set up a payment plan that is a combination of both of these examples, two or more separate deposits for short term goals and long term goals.

Still struggling to find any money to commit regularly to your savings plan? Consider focusing on just depositing work bonuses, pay raises any other extra money that comes your way until your circumstances change.

When money is tight, putting away money for a rainy day is hard - blaming the rain for not putting away money is easy. Pay yourself first today and your efforts will be handsomely rewarded tomorrow.

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