Friday, January 28, 2011

Paying yourself first

If you read financial planning books - and maybe even if you don't - you'll have heard of "paying yourself first." It sounds simple, right? At the beginning of the month, or whenever you're paid, you take a set amount of money and immediately direct it towards savings, before you have the chance to spend it. A well-known proponent of this method is the author of The Wealthy Barber; his book advised young people to set aside at least ten percent of their earnings to invest for the long-term. This is still sound advice today, decades after the book was first published, however, times have changed: levels of personal and household debt have risen, and our lives (frequently referred to as "lifestyles" by those who are trying to sell us something) are padded with gadgets and services we don't really need. Simply put, more is available, and so, we feel compelled to have more. The question is, how do you pay yourself first with so many competing interests out there, all waiting to tear a chunk out of your hard-earned money? How can you come up with ten percent if you are coming up short every month, and how can you possibly save more?

The first step, obviously, is to pay off debt. In order to pay off my credit card bills, I learned to set aside $600 a month, which is slightly more than 20 percent of my take-home income. In the process, I learned what was really valuable to me in terms of how I spend my money. I think "value" - or lack of it - is why many budgets fail. Simply earmarking a certain amount of money for various categories of your life - housing, food, clothing, transportation, entertainment - isn't going to stick unless you address two major issues: why is it important to you to save money, and what is the value of any given product, service or activity to you, relative to your goals? When I applied this formula to my situation, I discovered the following:

-Saving money is important to me because I value my independence and the more money I have, the less and less I will have to work - at least at the things I don't enjoy.

-In light of this future freedom, I realize certain other things are of little value to me. For example, having Internet at home. Some people would say that you need it. I view it as an unnecessary expense. If I need it there is a library up the street. What will I use it for if I have it at home? Mostly for Facebook and other time-wasting activities, which may further prevent me from reaching my goals by sucking up valuable time I could be using to improve my life. Not having internet does not detract from (and may well improve) the quality of my life outside of work.

-By the same logic, housing is a huge expense for me, as it is for most people; a cheaper monthly cost would accelerate my savings. But, what is the value of my home to me? My condo is a retreat from the insanity of the city. I feel safe and secure here. To me, it is worth every penny I pay in interest (though the same might not hold true if I was paying rent, as the ownership aspect is part of what makes me feel secure). Do I need to spend $1500 a month on housing? (That's the total cost of my mortgage, condo fees, taxes and utilities). Of course not. I could rent a room for$500 a month and save that extra thousand dollars. That may be feasible for some people. Having lived that way, I know it's not worth it for me; I'd rather cut other areas, or do freelance work to make up the difference. Additionally, as a long term investment, real estate is generally a good bet, and so far I have been lucky. There will be people who disagree with me and say that you should slash your biggest expense - housing - first and foremost, and if that works for them, that's great. The thing about paying yourself first is that you get decide what's important to you and why. I don't look at it as making "sacrifices" even; it's not a straight equation of one thing for another. It's a strategy as opposed to a tactic - one that will help you build the kind of life you want rather than one that makes you chip away at vague or dubious goals within restrictive parameters.

Another thing that is completely unimportant to me is having a car. I don't think it impacts my quality of life not to have one - certainly not in a city like Toronto - and I have planned where I live and work to be congruent with public transit and walking. But, I know people who simply cannot give up the idea of the car because it represents freedom to them. I, on the other hand, see everyone (except cyclists and pedestrians) stuck in the same traffic jam.

By working through this value exercise, the act of paying yourself gets easier. You will see what you can comfortably afford - be that ten, twenty or even fifty percent of what you make. Any percentage you can afford, no matter how small, represents progress. Currently I have a sum of thirty percent in my sights - or roughly $1,000 a month. This will be my first month on this schedule; I'll see how it goes. I don't anticipate it will make me miserable or cause me to really miss out on anything socially, but if it does, I may have to readjust my value assessments. Money doesn't buy happiness - but it can improve your quality of life in the long run, if you take the time to figure out what you really want and what you think it's worth to you.

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