New Way to Pay Yourself First
Most of us have heard the phrase "pay yourself first." This is a financial planner’s way of saying that when your check comes in, you should take a certain amount and put it in savings before you spend anything, instead of spending first and saving whatever is left over at the end of the month.
While this is popular practice because it’s a great way to maximize your savings, many people struggle with making it work and building a significant savings balance. Recently, however, I've seen people overcome the struggle and implement it successfully by making one small change.
1. Determine how much you need to cover your monthly living expenses.
2. Direct all your income into an investment account. This means everything from paychecks and bonuses to gifts – all of it goes into the investment account.
3. Instruct your advisor to leave enough cash in the account to fund three to six months’ living expenses.
4. Set up a recurring monthly withdrawal to transfer your living expenses to a checking account for spending. Or If you prefer to get paid more frequently, you can have it set up weekly or bi-weekly.
For example, Bob and Sally both have jobs. Bob's income is inconsistent and may range from $5,000 - $15,000 per month. Sally receives a regular salary of $10,000 per month. They agree that a reasonable amount for them to spend is around $10,000 a month.
All income is deposited directly into their brokerage account. They always have enough cash in that account to fund the $10,000 they need for monthly living expenses for three to six months. They have a recurring transaction set up that automatically transfers $10,000 from their brokerage account at TD Ameritrade to their checking account on the first of every month. They save more because they save first, and monitoring their budget is easier because everything in their checking account is spendable.
Making it work
The key to making this work is in directing income to a brokerage account rather than a savings account at your bank where the money is too easy to access. This builds in a great accountability buffer; you’ll be far less tempted to spend savings for unnecessary things if you have to call your advisor to withdraw extra funds.
This method is helpful for everyone, but it is particularly good for people with inconsistent income, such as commissioned sales reps, self-employed people, etc. And it’s not just a concept for young adults in the early stages of a career. It’s also beneficial for people who are preparing to retire because it is essentially a rehearsal for the way they will be living in retirement. Try it and see what great results it produces for you.