For many people, saving is tough. Between housing, utilities, groceries, transportation, credit-card debt, student loans, and other expenses, there never seems to be enough left to set aside for long-term savings. And that's the problem. Most people try to save something out of what's left over instead of saving first.
One of the oldest rules of personal finance is to pay yourself first. All the money books tell you to do it. All the personal finance blogs say it, too. Even your parents have probably given you the same advice. In fact, it's one of the fundamental tents of the Get Rich Slowly philosophy!
But what's the best way to do it? What's the most effective way to pay yourself first?
While I was writing Your Money: The Missing Manual, I benefited greatly from the advice of Dylan Ross, a Certified Financial Planner (from Swan Financial Planning) and a long-time GRS reader. One thing Dylan stressed over and over was that I was looking at savings wrong. I kept writing that you should take whatever money you have leftover in checking at the end of the month and move it to your savings account.
“There's a better way,” he told me. “People often have more success if they put money into savings first, and then transfer what they need to checking.”
It took me a while to understand what he was trying to say; it seemed like he was splitting hairs. Now, however, I realize that Dylan was espousing the true spirit of “pay yourself first”.
This probably seems a little vague to many of you. How would you actually go about following Dylan's advice? Here's a simple three-step process to make savings a priority instead of an afterthought:
- Open a high-interest savings account. Although “high-interest” is something of a misnomer lately, eventually it'll make a difference. I use ING Direct for my savings, but there are many other great options. (If you're curious, you can read more than 1700 GRS reader reviews of high-yield savings accounts here.) I'm a fan of keeping my savings account at a different bank than my checking account — it just makes it that much harder for me to tap my savings on a whim.
- Deposit your paycheck to your savings account. If possible, have your paycheck automatically deposited. (The more you can automate this process, the easier it will be to save.) This is the key to Dylan's plan. By putting the money into savings instead of checking, you don't have “extra” cash sitting in your bank account at the end of the month that can be mindlessly spent on other things. Plus, the money's already in your savings account, so you don't have to remember to move it.
- Set up regular transfers from savings to checking. Based on whatever system you have — a detailed budget, a rough guess based on last year's spending, whatever — schedule monthly (or weekly) transfers into your checking account to take care of routine expenses. The money left in savings stays in savings.
The difference between the checking-first and savings-first systems may seem trivial, but Dylan swears it works. As he reviewed the manuscript to my book, he flagged every every instance where I encouraged readers to save by moving money from checking to savings. “You have it backwards, J.D.!” he said.
I have my own method of paying myself first, and it's similar to Dylan's advice, but on a bigger scale. I don't pay myself first with each paycheck; instead, I try to front-load my saving every year.
That is, for the first few months, I save as much as I can. I set money aside for retirement, taxes, and other goals. I'm more frugal during the first half of the year, and there isn't much left over for indulgences.
Once I've set aside all the money I think I'll need, I'm able to loosen up and spend more on the things I want. I still save more throughout the year, but after I've met my initial goals, all other savings are a “bonus”.
For years, I struggled to develop the saving habit. As with repaying debt, I tried to get started, but Real Life always seemed to get in the way. Even after I finally opened my first savings account — which was only about five years ago — my efforts were only half-hearted. It wasn't until I learned to pay myself first — which, in my case, means at the start of every year — that I actually achieved any sort of success.
But you know what? Now that I'm a saver, I like it!