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HNRE blog series | Pay Yourself First

HNRE blog series | Pay Yourself First

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While building out our Hack Now Recommendations page, I spent a lot of time thinking through what books, blogs, and products have worked for us and which haven’t over the last many years. While thinking through those recommendations, I kept coming back to our family’s financial tenets that we use to guide our investing and budgeting strategies.

Since these tenets are more guidelines and less recommendations, I felt compelled to write a blog series documenting each one and the strategy we use for each on our path toward FIRE. This series will cover the lessons we’ve learned and principles we’ve adopted over years of making good, and sometimes bad, decisions with our personal finances.

I’m hoping that you’ve heard of most of these concepts before but will learn a lot more about how to use them and how to make them your own.

For our first in the series, I’d like to focus on possibly the most important tenet of all, paying yourself first.


Paying Yourself First

You may have heard this mantra a time or two in the past. Probably many times if you’ve been following us on Twitter. I’ve said before that it’s “pretty much my favorite financial tenet” and the foundation of what has put us on the path to FIRE. It’s such a simple concept, that if taken only at surface level, you may miss its true beauty.

You may have heard about paying yourself first from Dave Ramsey. I believe that was the first time I had heard of it. And while I don’t subscribe to all of Dave Ramsay’s recommendations, I have found this one to be the most important.

In fact, once I heard him explain the principle, I realized that I had been practicing it for years already. The concept is simple, instead of living paycheck to paycheck and spending all of your income each pay period, you set some aside for yourself. I know that might sound confusing – wouldn’t you still end up spending the money you put aside for yourself? This is where the secret sauce comes in – automated investing.

Since my very first mutual fund investment right out of college, I’ve been siphoning off a portion of my paycheck automatically and funneling it directly into an investment vehicle. This is the key – you need to trick yourself by cutting out a portion of your income for investment before it ever hits your bank account.

It works like this:

Take home pay: $2000
Automated investment (paid first): $400
Amount that goes into your checking account: $1600
Amount you use for budgeting: $1600

Did you notice the secret?

The secret is that the amount you’re budgeting with is the $1600, not the take home pay of $2000! This is the whole principle – simple right?

What you’ve done is “secretly” hid the first $400 of your paycheck from yourself. You haven’t squandered it on a girl, a guy, a fancy dinner, new clothes, etc. You’ve siphoned it off without even realizing. This money now starts growing via the powerful concept of compounding.

Compounding is the single, greatest method to early retirement that there is. There is only one catch – you have to put money into your selected investment vehicle on a regular, repeatable basis. This is what paying yourself first does. It creates a dollar cost averaging investment strategy that grows via compounding without any effort of your own.

The true beauty is that you trick yourself by living on a smaller “paycheck” each month, while your money is magically growing and compounding every day. The beauty is in the simplicity.

Let’s use a realistic example. Below I show what would happen to an automated $400 invested monthly 50% into a Dow ETF and 50% into an S&P 500 ETF. Why did I pick these two? Because I easily found their compounded 50 year average return online* – the Dow is 5.8% and the S&P 500 is 6.2% – therefore I decided to use 6% as the average annual return.

Check out how our automated investment (paid first) grows over time:

compounding

Check out the free money! The free “secret” money. Can you imagine the numbers if you invest more or if the market outperforms 6%? Holy cow!

Everyone should be doing this! Whenever I get asked how to invest or what to invest in I respond with – pay yourself first and invest in low cost ETFs (we’ll expound on this later in the series).

Honestly though, no joking here, if this is all you do from an early age you’ll be set for early retirement. If you make any investment decisions, young or old, make sure you start by paying yourself first.

Need one more reason to start today? Ok, paying yourself first and dollar cost averaging takes you out of the market timing game. I’m sure you’ve heard that you can’t time the market. If everyone says this why do you think you can do it? Don’t even try. Simply set a regular draft from your paycheck or checking account so that you pay yourself first automatically before you pay any creditors.

This way your budget always starts with the income left over after you’ve already paid yourself first and automatically invested into the compounding machine.

What do I ask for the free “secret” advice? Just one thing, please be so kind as to skim a few fractions of pennies off of that compounding and send them my way! Thanks Michael Bolton!

Office Space
Office Space
*https://larrycheng.com/2010/01/01/u-s-stock-performance-over-50-years/ 

Be on the lookout for the next tenet in the series – Low-cost ETFs.

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6 thoughts on “HNRE blog series | Pay Yourself First

  1. I’m so glad you chose to write about this. I believe I first heard the term “pay yourself first” from reading books written by David Bach. He’s into automating everything. The beauty is, you don’t miss what you don’t see! Take the money right off the top and sock it away. Sometimes it can be scary, I’ll admit. When Mr. Groovy began maxing out his 401K, he suggested I do the same with my 403b. But I resisted. I feared we wouldn’t have enough to live on. So he then suggested I add 2% each year which I was OK with. After several years of not missing that money I went all in and maxed mine out too (which also helped with our tax bracket).

    Thank you so much for adding our website to your Recommendations page! We really appreciate it.

    1. Mrs. Groovy,
      Thanks so much for the comments. I agree that it can be scary. Most everyone assumes that if they’re spending their full paycheck each month then there is nothing to cut back on. But when you “trick” yourself and “sock it away” like you said, then you just learn to spend what is leftover. It’s really a forcing function. I really like your idea of upping the amount 2% until you notice it, that’s a great way to jump in and test the waters.

      Thanks again and welcome to the Recommendations page!

  2. When I found my first job, I discovered the power of “pay yourself first.” I went through a benefits orientation program with HR and they offered me free money to match my contribution. I watched the Bloomberg channel as a kid, so I kind of knew what they were talking about. I lived on so little as a college student, so I knew I could still make enough money even after matching my employer’s contribution. (I didn’t know I was “paying myself first” until I read more into the concept this year. Ha!)

    1. Yep, that sounds similar to me. Paying yourself first just made sense. But it doesn’t to everyone. It’s a great first step that can force those who aren’t as financially inclined into a de facto budget.

      It’s really such a powerful concept that I wish everyone understood it.

      Thanks for the feedback Claudia!

  3. This is the best rule of thumb for savings that I have come across and followed religiously. It is much easier to stretch to the next month with the budget you have if you know that is all there is. When you leave the extra $400 in an account it becomes the back up plan. This way, if it is invested, it is already out of sight and mind. Great tip!

    1. Miss Mazuma,
      I agree completely. Get that money automatically invested then live off the rest. You don’t miss it but will have the peace of mind that all the while you’re investing for your future.

      Thanks for reading!

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