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Paying Yourself First

One of the foundations of personal finance is the notion of paying yourself first. What does this mean? The suggestion is that you should treat the funding of your portfolio just like you do any other bill with the goal of putting in at least 10% of your before tax income.

When I first started full-time post graduation work I was making a fairly decent salary but I wasn't able to even come close to saving 10% of my before tax income. I was lucky if I could save 5% of my after-tax income. I'm sure there are many people in the same situation.

So how is it possible to get to the point where you are actually saving 10% or more of your before tax income? You need to view the 10% level as a goal. It isn't something that you have to do all at once. You can work towards that goal over as long a time as is necessary to reach it (within reason of course). One very simple way of reaching the goal is to save your raises and your bonus. Say you are currently making $40,000 a year and you get a 2% raise. That means that you will be making $40,800 now. Let's also say that you were only saving $50 a month ($600 a year or 1.5% of your before tax income) before you got the raise. After the raise you should be taking home a little more than 60% of that $800 or around $480 a year, $40 a month. Since you were managing to survive on the $40,000 you were making before you got the raise, there shouldn't be any reason that you couldn't survive on that much after the raise. So that extra $40/month could go right into savings and you have increased your savings rate by 80% to a whopping $1080 a year or 2.65% of your before tax income. If you get a bonus during the year you could funnel as much of that as possible (say 50% to your savings account and 50% to do with what you please, it is a bonus after all you may want to enjoy it a little bit).

By being consistent with putting your raises and a portion of your bonus into savings over time you can reach the goal of paying yourself first and saving at least 10% of your before tax income. It may take six, seven, eight years but it is possible to get there and it should be quite painless as you shouldn't notice the extra money going into savings since you never got used to spending that cash in the first place.
category: Personal Finance posted on Tuesday October 16, 2007 at 07:23:10 by: 0xCC