Each month you pay your mortgage lender, the electric company, the trash collector, etc. But do you pay yourself?
One of the most basic tenets of sound investing involves the simple habit of “paying yourself first” or, making the first payment of each month into your savings account.
Americans’ saving patterns vary widely. Too often, short-term economic trends can interrupt long-term savings programs. For example, the U.S. Personal Savings Rate jumped from 3.5% to nearly 8% in May 2008 during the housing and banking crisis. It then rose and fell sporadically as the economic environment appeared to stabilize.1
The Genius of Pay Yourself First
Anyone who’s ever managed their own finances knows that saving can be a challenge. An endless stream of expenses demand a piece of each month’s paycheck. Herein lies the genius of paying yourself first: you get the cream at the top of the bucket, and not the leftovers at the bottom.
The trick is to prioritize by putting your future first. Saving may mean a small lifestyle change in the beginning. But most individuals want to see their net worth steadily increase. For them, saving becomes more of a long-term commitment than a short-term challenge.
Putting Your Money to Work
What will you do with the money you save?
If retirement is your priority, consider taking advantage of tax-advantaged investments. Employer-sponsored retirement plans, such as 401(k)s and 403(b)s, can be a great way to save because the money comes out of your paycheck before you even see it. Also, as an added incentive, some employers offer to match a percentage of your contributions.2
For money you’ll want to access before retirement, consider placing the funds in a separate account. When the balance hits your target, you can move the money into investments that offer the potential for higher returns. Of course, this may mean exposing your money to more volatility, so you’ll want to choose vehicles that fit your risk tolerance, time horizon, and long-term goals.
In the pursuit of growing wealth, sound habits can be your most valuable asset. Develop the habit of “paying yourself first” today. The sooner you begin, the more potential your savings may have to grow.
Ups and Downs
The U.S. Personal Savings Rate, shown below, historically has fluctuated as Americans are influenced by the short-term economic environment.
Sources: Bureau of Economic Analysis, 2015, for the period July 1, 2005 through June 1, 2015. National Bureau of Economic Research, 2015
Bureau of Economic Analysis, 2017
Distributions from 401(k), 403(b) and most other employer-sponsored retirement plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.