Fundamental #1: Pay Yourself First
This article, “Pay Yourself First,” is the first in a five-article series that discusses the Five Fundamentals of Fiscal Fitness, designed as a basic starting point to help you take control of your finances. If you do nothing else, following the Five Fundamentals will help you ensure that you are able to live within your means. There should be more to your financial plan than the Five Fundamentals, but following them allows you to move beyond living paycheck to paycheck, and focus on longer term financial goals, such as retirement planning, or saving for a specific goal, like a home purchase.
What does “Pay Yourself First Mean?”
So, what does it mean to “pay yourself first?” Simply put, it means that instead of trying to pay your bills, then save whatever is left over, you do the opposite. You force yourself, through automatic deposits, to set aside a certain amount of your income to your savings and investments, then live on the rest. A perfect example is the Thrift Savings Plan. You automatically deduct a certain percentage of your base pay every month, and the rest goes into your paycheck.
You can read any number of articles that talk about the psychology behind this theory, but the short answer is: “If you ‘pay yourself first,’ you prioritize your savings and force yourself to live within your means.” We’ll discuss some of the ways you can pay yourself first below, but let’s talk about how much you should save.
A reasonable savings rate goal is 10%. However, when I say 10%, I don’t mean that you should pay yourself first during your earning years, then forget about savings when you retire. I mean, commit to a lifetime of always saving 10% of your income, regardless of where you are in life. If you’re already saving more than 10%, that’s great! Obviously, saving more allows you greater financial flexibility. However, for a lot of people, 10% savings is a significant challenge. Let’s stick with 10% for now and explore why it’s important to save at least this much.
- 10% is achievable. If you’re just starting to pay yourself first, it might seem like a lot. However, if you set 10% as a goal, and commit to some of the steps that I outline below, you’ll find that you can do this. You’ll also find that the steps I outline compound over time, resulting in a snowball effect and becoming easier as you go.
- 10% savings means that you’re always living within your means, even in retirement. If you’re only living on 90% of your income, this is sustainable for the long-term. You might ‘feel a pinch’ when you see an unexpected bill, but saving 10% allows you to be in a financial position to pay it and move on. Even after retirement, reinvesting 10% of your income from all sources (not just pensions), will help you keep focus on living within your means.
- 10% allows you to adjust to inflation. We haven’t seen high inflation rates for quite some time. However, let’s assume that at some point, inflation might impact your life. If the price of everything suddenly went up 10% in the next year, you’d be in a much better position to make adjustments than you would be if you didn’t pay yourself first.
- You’ll be in a better position to determine if you’re on track to reach your financial goals. While you can’t predict many factors that go into retirement planning, such as investment results or inflation rates, having a consistent savings rate is a key first step in building confidence in your planning. If you don’t consistently save money, you’ll never be able to have confidence that you’re on track.
How do you pay yourself first?
In the military, you have a great opportunity to develop great savings habits. Even if you start off only saving $10 per payday, you can develop a plan that will eventually end up in saving 10% (or more) of your income. Here’s how you can do so while you’re on active duty.
- Figure out where you currently stand. You get a monthly LES. Take a look at it, and write down three things:
- Total entitlements. This includes pays, allowances, and bonuses. Your savings goal should be 10% of this amount (not just base pay).
- TSP allotments. TSP is taken out of your check as a percentage of base pay. Unless you select bonus or incentive pays, TSP is not taken out of them. Also, allowances are excluded from TSP deductions. While you can change your TSP allotment, don’t fall into the trap that a 10% TSP allotment meets your goal—your goal should be 10% of your pays, allowances, and bonuses.
- Other discretionary allotments. You might have allotments that go to a savings account, or Treasury bonds. As long as these allotments go to your savings (as opposed to child support, alimony, or college savings), this counts towards your 10% total.
- Once you determine where you stand, figure out if you can save more, right now. If you look at your spending habits, I think you could find a way to save at least 1% of your income without even feeling like it’s much of a sacrifice. Whether it’s movies, dinners, Starbucks, or whatever, if you’re not currently saving 10% of your income, you’ll probably find a way to save at least 1%.
- If you cannot save any more right now, then find a point in the future when you can start. In the military, there are several opportunities:
- If debt is a concern, make that your focus. However, commit to something, even if it’s only $10 per payday. Make it an allotment that shows up in your LES. $10 per payday isn’t a lot. However, it’s a starting point. And if you make it a commitment, it will only go up. Every time you pay off a credit card, think strategically about what you’ll do with the extra money from that credit card bill. While most of it should go to the next credit card, put a modest amount (say, another $20 per month), towards your savings. If you have 5 credit cards, and you eventually pay them off, you’re already up to $120 per month, and you’ve got extra cash that you’re not paying credit cards on. It’s an easier mental shift to ramp up a savings habit that you’re already committed to than it is to completely start from scratch ‘someday.’ When you’re in debt, you should definitely make sure you’re able to make your debt payments, but start saving something, even if it’s small.
- Save 50% of every pay raise. While promotions aren’t guaranteed, I’ve never met anyone in the military who never got promoted, ever. We might not get promoted as often as we’d like, nor to the paygrade we’d like to achieve, but we do get promotion pay raises. We also (usually) get time in service pay raises every two years. Finally, if those two options get maxed out, we also get an annual raise (usually, although they’ve been embarrassingly small recently). All of this counts. Let’s look at a hypothetical O-5, who was promoted in September 2015. In July 2015, this O-5, stationed in Tampa, made $10,002.63 in total entitlements, as an O-4, over 16 years. His savings goal should be $1,000.21. In January 2016, this O-5, who is now over 18 years, has $11,195.53 in entitlements, which means his savings goal is $1,119.55. His total pay raise is $1,192.92 ($11,195.53 – $10,002.63 = $1,192.92). If he saved ½ of this amount ($596.45), that number itself is over ½ of his new savings goal. Even if he was only saving 5-6% previously, just setting aside ½ of his pay raises over this six-month period would put him over the top. Just imagine the combined benefit of doing this over the course of a 20 year career!
- Save 25% of any additional income (such as a second job). It’s idealistic for an active duty member to expect their spouse to turn over 100% of their take-home pay from their second job to the savings goal, unless this is part of a joint effort. It’s great if you’re able to agree to that goal. However, you might find that you’d rather start with a lower goal, such as 25%, then see how you can ramp up from there.
- Congratulate yourself on your progress. I don’t mean buying a new car just because you feel like you deserve it. However, if you’ve just committed to taking a $250 pay raise and putting ½ of it towards your savings plan, perhaps you can use the first month’s remaining raise (in this case, $125) towards a nice dinner out, as a celebration. Same goes for reaching a new milestone, such as getting to 5% or 10%. Just remember not to go overboard, and that your primary goal is to pay yourself first.
Paying yourself first by setting aside at least 10% of your total income is a crucial first step in the Five Fundamentals of Fiscal Fitness. The Five Fundamentals help establish the foundation for your financial success. In the next article, we’ll discuss the role of liquidity, and why liquidity is vitally important.
So, do you pay yourself first? If so, how much is your current savings rate, and what is your goal? Please leave a comment below and let everyone know how much you save. Also, feel free to subscribe to this blog if you’d like to automatically receive future posts via email.
Caveat: Five Fundamentals of Fiscal Fitness is a money management philosophy created by Bert Whitehead, a prominent thought-leader in the fee-only financial planning world. Bert’s philosophy has been standardized by the Alliance of Comprehensive Planners (ACP), a non-profit membership of like-minded, fee-only financial planners dedicated to helping clients avoid the pitfalls of the financial services industry. Disclosure: I am a dues-paying member of ACP, and fully believe in the five fundamentals of fiscal fitness. Please feel free to contact me with any questions you may have about ACP and its philosophies.