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When you hear the word “budget,” your first thought may be to think about all of the money you’ll need to set aside to pay others. But not all budgets prioritize spending categories in the same way. The pay-yourself-first budget includes a line item at the very top of the list for what may be your most important spending category: you.
What is a pay-yourself-first budget?
Where other budgets might have you earmark funds to pay for spending categories like your utility bills or groceries first, a pay-yourself-first budget (sometimes referred to as a reverse budget) prioritizes goal-based saving categories like retirement and investments before tackling short-term expenses.
“By paying yourself first, you can avoid some of the common obstacles to savings, like overspending and running out of money to put into savings or simply forgetting to put money aside for savings while you focus on other goals,” says Heidi Johnson, director of behavioral economics at Financial Health Network.
Of course, with every budgeting strategy, there should be some balance. You should be realistic about how much you can comfortably afford to pay yourself while still covering your basic cost of living.
How to create a pay-yourself-first budget
When building a pay-yourself-first budget, you’ll need to start by shifting your mindset to focus on the idea that this budget will be centered around your long-term savings goals, not your short-term expenses.
If you’re looking to try the pay-yourself-first strategy, here’s how to start:
- Calculate your income. Before determining how much you have available to save and cover your expenses, you’ll need to have a solid idea of how much income you have flowing into your bank account each month. If you don’t know off the top of your head, comb through a few of your most recent pay stubs and bank statements to determine the exact amount of your paychecks, side hustle and investment income.
- Decide what your savings goals are. Think beyond covering the cost of your day-to-day or even month-to-month expenses. Ask yourself what your long-term goals are and how much you need to save each month to reach those goals within your desired timeline. Perhaps your goal is to retire early or save enough to buy a home. Once you’ve settled on what you’re saving for, you can set aside a specific amount for those goals and then use the leftover funds to cover your day-to-day expenses, like your upcoming car insurance payment, rent, utilities, and groceries.
- Choose a savings vehicle. Deciding where you’ll put your savings is equally as important as deciding how much to save each month. The account you put your savings in can play a huge role in how fast you’re able to reach those goals. Pro tip: You should opt for a high-yield savings account so that your savings continue to grow over time.
- Reevaluate periodically and make adjustments. While some budgeting strategies require less maintenance than others, you should still plan to revisit your budget periodically to determine if this strategy is still working for you and adjust your savings goals to account for changes in your income, debts, or expenses.
“The amount of money that you save will vary person to person depending on your income, goals, and other circumstances,” says Kendall Clayborne, a certified financial planner at SoFi. “To determine how much money you can feasibly save, I recommend that you start by looking at your current fixed expenses and spending habits. You can then break down your goals to determine how much you need to save to reach your goal versus how much you may want to spend.”
Here’s what creating a pay-yourself-first budget might look like in practice:
Say you bring home $3,000 each month, after taxes, and your top two savings goals are to save for a down payment on a home and build six months’ worth of living expenses in your emergency fund within the next 12 months. In order to hit your savings goals within the next year you would need to save the following each month:
- Total emergency fund goal: $10,000
- Amount needed to hit goal: $3,000
- Monthly savings goal: $250
- Total down payment goal: $35,000
- Amount needed to hit goal: $4,000
- Monthly savings goal: $333
- Total monthly savings goal: $583
This means that after you’ve put $583 toward your savings and emergency fund, you’d have $2,417 left to cover your everyday expenses.
Is the pay-yourself-first budgeting method right for you?
Like most things, whether this budgeting strategy is for you will depend on your unique situation and finances.
One of the perks of using this budgeting method is that it’s pretty hands-off and can take just a few minutes to set up. So if you’re looking for something more streamlined, it could be a good option for you.
And once you’ve figured out your income, savings goals, and how much you feel comfortable putting into your savings account, turning those plans into action is as simple as automating your savings within your existing bank account. You can usually do this through your online bank account, mobile app, over the phone, or in-person at your bank’s branch. All you have to do is select the amount you’d like to transfer into your savings and how often those transfers should be made, and then you’re all set.
“You can have direct deposit set up so that a portion of your paycheck each month goes directly to your savings account,” says Clayborne. And if you feel like keeping your savings and checking accounts under the same roof may tempt you to overspend, you can also opt for a bank account at a different bank to keep things separate and keep working toward your goals.
Pros and cons of a pay-yourself-first-budget
Not all budgeting methods will work for you. Weighing the pros and cons of this method can help you decide if it’s the right strategy for you, or if you should head back to the drawing board.
Pro: A pay-yourself-first method reinforces a savings-focused mentality. Rather than accounting for all of your daily expenses and then seeing what, if anything, you have leftover for your savings goals, you’re prioritizing those long-term goals first and making sure that they don’t slip through the cracks.
Pro: This kind of strategy forces you to be strategic about how you use the funds you have leftover and live within your means. It reduces the likelihood that you’ll fall victim to a lifestyle inflation trap and let your savings goals slip through the cracks.
Con: If you have high-interest debt, this strategy could make it more difficult to pay down those balances. In these cases, you may want to prioritize chipping away at your debt before you tackle your loftier savings goals.
Con: It can be difficult to predict how much you’ll need to save for unexpected expenses and you don’t want to create a situation where you’re constantly pulling money out of your savings, or potentially incurring overdraft fees, because it’s hard to anticipate how much you should be keeping in your checking account. “Most people perceive previous expenses like a flat tire or a child needing braces as unusual, so they fail to account for similar expenses in the future,” says Johnson. “This can lead to an overly optimistic budget.”
The takeaway
If the thought of spreadsheet maintenance and constant number-crunching has turned you off to traditional budgeting methods, the pay-yourself-first method might be a viable option for you. It’s easy to set up, maintain, and adjust as needed if there are any major changes in your income or financial priorities.
“This strategy usually works best for people who find themselves tempted to spend money if they see it in their checking account,” says Clayborne. “By moving the money to another account and not seeing it as available to spend, you can trick yourself into saving painlessly—out of sight out of mind.”
