Always pay yourself first

Added on 11/06/2009 17:30

Right now we are all being bombarded with a million and one ways to save money whether it’s shopping around for better deals, reducing credit card debt or reducing the number of lattes we buy each week.

Here’s a sure fire way of making some money... always pay yourself first.

How do you do it? Well, instead of paying the landlord or the mortgage lender the moment your salary arrives in your account, you pay yourself first. You don’t pay for groceries or car insurance, the gas bill or mobile phone bills before you pay yourself. You certainly don’t pay the café owner that small fortune for a double latte and muffin first; you pay yourself instead. Ideally, you even pay yourself before you pay the taxman.

By paying yourself first, that is, by earmarking a portion of your weekly or monthly wage to a savings or investment account, you do a number of things: first you reward yourself and not others for all the hard work that is involved in earning that wage. Next, you get into the savings habit. And if the designated sum is deducted directly from your salary, within a short time you won’t even notice the deduction. 

Your lifestyle will quickly adapt to a lower cash balance. You will still end up paying all the bills you need to but you will also watch a steady pile of money build up in a savings or investment fund that has a life of its own.

But there’s more to paying yourself first than meets the eye.

Drum roll please …it’s the magic of compounding interest. 

If you are in a good high interest savings account that calculates interest daily and pays it monthly, then while your regular amount is accumulating, in the background the interest you earn is being added back to the principal. This means you earn interest on top of interest from that moment on.

Learn more about setting up a Regular Savings Plan with your RaboPlus account

The figures don’t lie, either.

If you start saving 10% of your income from the moment you start working, and you earn, say, a starting salary of $35,000, assuming that wage goes up by a modest 3% per annum and you earn a steady 5% growth per annum on average as rates will move up and down over the period, the ‘pay yourself first’ fund will be worth over $21,000 gross after just five years.

The magic of compound interest is still at work and after 10 years there will be over $51,000; keep going for another 10 years and your next egg has built up to over $150,000.

Try our Regular Savings Calculator to work out how much your savings will be worth and how much interest you can earn over time.

Once established, a saving habit should last a lifetime. It’s the first step – earmarking that 10% of salary to a good high interest savings account – that will be hardest part of the exercise. It’s also a great habit to teach your kids. I opened savings accounts for my kids when they were born and deposit a steady amount each month into it.

Here are some good reasons to pay yourself first and reward yourself, not just strangers, with your hard earned wages:

1. Your lifestyle automatically adjusts to the remaining available cashflow.

2. You benefit from the miracle of time on money...also known as compound growth.

3. You can achieve important milestones - like home ownership and early retirement - with confidence and without disproportionately high costs.

4. It helps you to build a solid credit reputation.

5. Good, regular savers rarely fall into serious debt.

6. You can create a cash cushion against serious unexpected events, like illness and job loss.

7. It can be very tax efficient if savings are channelled into a pension fund.

8. Your accumulated fund can be the launching pad to financial independence if used to set up a business or to invest in real, income-generating assets.

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