How can “Pay Yourself First” budgeting help you reach your financial goals faster?

There are various budgeting methods that you can use to allocate income towards expenses and investments. Most budgeting methods work the traditional way, allocating a higher income share for expenses than investments. However, the pay yourself first budgeting method prioritises investments towards financial goals over discretionary expenses.

In this article, we will understand the pay yourself first budgeting method, how it differs from other conventional budgeting methods, and how you can follow it to achieve your financial goals faster.

What is pay yourself first budgeting?

Pay yourself first is a budgeting method in which you prioritise yourself and your financial goals above discretionary expenses. As soon as you get your regular income, you set aside money for your savings and investments towards your financial goals.

The remaining income can then be directed towards essential (needs) and discretionary (wants) expenses. The method can help you reach your financial goals faster than other budgeting methods and thus achieve financial independence.

For example, let us assume that you have a monthly income of Rs. 50,000, and your financial goals require you to invest Rs. 15,000 monthly. With the pay yourself first budgeting method, you will first set aside Rs. 15,000 monthly for investments towards financial goals. The remaining Rs. 35,000 can then be used for monthly expenses.

How is pay your first budgeting different from other conventional budgeting methods?

Conventional budgeting methods focus on allocating a major portion of the income towards expenses rather than investments towards financial goals. Many people follow the traditional equation:

Income – Expenses = Savings and investments

The challenge with the above equation is that many people spend either a major portion or all of their monthly income on expenses. Some people spend more than their monthly income using credit cards when their savings account runs out of money. As a result, there is either less or no money left for savings and investments. With little to no investments, financial goals suffer.

The pay yourself budgeting method flips the traditional equation as follows:

Income – Savings and Investments = Expenses

Pay yourself budgeting is also known as reverse budgeting.

How to follow the pay yourself first budgeting to reach financial goals faster?

Make a list of all your financial goals. Some of these may include:

1. Emergency fund
2. Term life insurance for the family bread earners
3. Health insurance for the entire family
4. Child higher education and marriage fund
5. Retirement fund
6. Down payment for purchasing a house
7. Annual vacation
8. Purchasing a vehicle
9. Fund for starting a business, etc.

Once your financial goals list is ready, calculate the monthly amount you must set aside towards these financial goals. As a next step, from your income, allocate money every month towards these financial goals. Use the remaining money for monthly expenses.

You may not be able to start investing towards all the financial goals at one go. Categorise the goals in short, medium, and long-term goals based on the time left to achieve them. Start investing towards short-term goals. As you move along, include the medium and long-term financial goals in your investment plan.

You can automate investments by giving standing instructions (SI) to the bank to auto-debit the amount for mutual fund SIPs, insurance premiums, recurring deposits, etc. The auto-debit date can be kept 1-2 days after the date on which you get your monthly salary/income, etc.

If you consistently follow the pay yourself first budgeting method, you will reach your financial goals faster than other budgeting methods.

Challenges with the pay yourself first budgeting

While the pay yourself first budgeting method has the advantage of helping you reach your financial goals faster, it has its share of challenges. The biggest challenge is meeting the monthly expenses from the remaining income after allocating money towards financial goals.

Earlier, we saw an example wherein an individual has a monthly income of Rs. 50,000 and needs to invest Rs. 15,000 towards financial goals, leaving the remaining Rs. 35,000 for monthly expenses. However, the Rs. 35,000 may not be enough to meet the monthly expenses.

To overcome the above challenge, an individual will need to evaluate their expenses, item by item, and see where and how much of their expenses can they cut down. But there is a limit to which overall expenses can be cut down. For example, essential expenses like groceries, utility bills, school fees, medical expenses, EMIs, etc., are non-negotiable. It is only the discretionary expenses that can be cut down.

In such a situation, an individual can start with a budgeting method like 50/30/20 budgeting. In this method, an individual needs to allocate income as follows: needs (50%), wants (30%), and savings and investments (20%).

Over time, an individual can get used to budgeting, identify the discretionary expenses that can be cut down, and slowly and steadily increase the savings rate beyond 20%. An individual can focus on paying up high-cost loans like credit card outstanding, personal loans, etc., to free up higher cash flows towards savings and investments.

Using the above methods, once an individual's saving rate has reached around 40% of income or higher, they may migrate to the pay yourself first budgeting method. Post-migration to the pay yourself first budgeting method, they can aim to achieve their financial goals faster.

Should you adopt the pay yourself first budgeting method?

The pay yourself first budgeting method is an excellent way to achieve your financial goals and attain financial freedom faster than other budgeting methods. However, most people will find it challenging to start directly with pay yourself first budgeting. Hence, they may begin with another budgeting method, like 50/30/20 budgeting, and gradually migrate to pay yourself first.

The pay yourself first budgeting method requires an individual to save and invest a high percentage of their monthly income, cutting into discretionary expenses, giving a feeling of living a frugal life. It is important to balance between spending some money on discretionary expenses to enjoy the present and investing towards financial goals to secure the future.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.