Pay Yourself First

I'd like to talk a little bit about this phrase that we have all heard many, many times from many, many sources. I have been hearing this for years and years and years. I always thought I knew what it meant. It's easy, right? Just throw $50 from my paycheck into savings and away I go. Well, guess how much savings that has gotten me? Not much. There always seems to be something else that needs to be payed first. Bills, outings, whatever. Or, once the savings reaches a decent number, it is always very tempting to use it to pay off a bit of debt, or go on a holiday, or buy something I want/need.

What I've learned recently, is that I've been doing it all wrong. I'm sure you all knew this before, but here's how it should work. Let's say every 2 weeks I get paid $2000. Before I even touch any of that, I have setup automatic transfers to take some of that money away and pay me first. Let's say $75 to my RRSP (401K for you Americans), $75 to my TFSA (Roth IRA), and $50 to a high interest savings account, for a total of $200, or 10% of my net. Before I even had a chance to touch that money, it's gone. That's the easy part. Now, here's where I (and everybody else) get into trouble. Let's say my hard expenses every 2 weeks come to $1500. Mortgage/rent, taxes, utilities, groceries, insurance, car, all that stuff. But this month, my car broke down and I need to get it fixed. It costs $500. So, $2000 - $200 = $1800. $1800 - $1500 = $300 discretionary income. $300 - $500 car repair = oh wait, I'll just take that from my savings account. Now my money, my savings account, just went to pay some guy to fix my car.

Or how about I decide to buy a house and I don't quite have enough for the down payment. No problem, I have $30,000 in my retirement fund. I'll just take that out (both the US and Canadian systems allow for this without taking a tax panalty as long as it is paid back in a specified period of time) and use it on my house. The trouble is, even if I pay that back in 5 years (which is a reasonable amount of time) that one little move just cost me a LOT of money. Let's say I was 30 when I took that money out and I'm going to retire at 60. So, over those 5 years, at 8% return (the market average since Moses parted the Red Sea) my $30,000 would have grown to almost $45,000. In 30 years, it would have grown to just over $300,000. But now, because I didn't pay it back for 5 years, I only have 25 years for it to grow. That means it is now worth only $205,000. That one move cost me $95,000!! All because I didn't understand what they meant when they said to "pay yourself first".

So, what's the alternative? Well, I'll let SNL explain it: http://garritson.com/videos/pages/dontbuystuff.htm
Don't buy stuff you cannot afford. Simple. Sure, I might have to wait a couple of years to put a downpayment on that house, but that's what my high interest savings account is for. Figure out how much you'll need, when you'll need/want it, and then you know how much you have to put away every month for it. When the time comes, you will have the money.

I highly recommend reading the book "I will teach you to be rich" by Ramit Sethi. He also has a very informative blog, http://www.iwillteachyoutoberich.com/. He explains it all a lot better than I do.

Dad