May 2, 2012
In this monthly column, Paul Kralik endeavours to put a positive spin on personal finance by empowering readers with practical tips and “good news” from the financial world.
Paying yourself first
It’s perhaps the simplest financial planning concept, but also the most important one. Paying yourself first involves putting aside money as soon as you get paid. The presumption being, if you set aside savings right away, you have created a forced savings plan. Too often, people pay themselves last. And after paying bills or buying that new pair of jeans, there isn’t much left at the end of the paycheque.
If you’re like most people, on some intellectual level you recognize the value of saving. However, paying the mortgage or rent, car payments, credit card bills, groceries, or fixing the roof often takes priority over saving. I’m not advocating making savings a priority over paying the rent, but one must have a sense of how much money is coming in and how much is going out. This is called budgeting. The underlying assumption with paying yourself first is that you’ll have funds left over at the end of the month. If this isn’t the case, changes need to occur first. But the power of saving small amounts over time cannot be underestimated. The key is discipline.
I’ll be the first to admit that it’s easy to talk about making financial changes, but much more difficult to follow through. So I’ve developed some easy-to-implement strategies. Firstly, make your savings inaccessible. If you have easy access to the funds, you’re more likely to give in to temptation and use the money for something else. Setting up a separate savings account is ideal. Even better is to use a registered account, such as an RESP, RRSP, or tax-free savings account. The benefit of using a registered account is savings earn interest tax-free, and in the case of RESPs and RRSPs, the funds are difficult to access and heavily taxed if withdrawn, making it less tempting to take money out.
Secondly, be realistic in the amount that you plan to save. This is where a budget comes in handy. Knowing how much you need to make ends meet each month is critical. In analyzing your spending patterns, be sure to add a little extra to account for unforeseen emergencies (gifts, vacations, house repairs, etc.). Start small… it’s easier to increase the amount later if you find you consistently have excess savings even after paying yourself first.
Thirdly, paying yourself first should be something you don’t have to think about. To accomplish this, ask your bank to set up an automatic transfer from your paycheque to a separate savings account. We pay bills monthly; why shouldn’t we be as diligent with paying ourselves? Once an automatic transfer is in place you won’t have to think about paying yourself — it’ll just happen and you likely won’t even notice.
Lastly, many will struggle with where to get excess funds to direct to a forced savings plan. Most people at some point will get a pay raise. Unfortunately, the majority of us end up increasing our spending, too. A colleague of mine received several promotions in a short period of time, effectively tripling his salary. Somehow he has more debt now than when he was making one-third of his salary. Granted, he now has a cottage, boat, and new car, but he’s trapped by debt payments. When we get a raise, it’s the ideal time to save the raise and continue living the same lifestyle we did prior to it. We can all learn a thing or three from Warren Buffett, who has paid himself $100,000 per year for the last 30 years, despite being worth $44 billion!