Should you pay yourself first?

There is an approach to investing, it’s called pay yourself first. Is it something you should be doing?

Article updated: 13 February 2019 2:00pm Author: Michael Baxter

Human nature is a funny thing. If we were all like Mr Spock from Star Trek, then there would be no need for psychological tricks such as pay yourself first, but we are not, so there might be.

Pay yourself first is simply a strategy in which you save before you spend. You save a set amount of money each month, immediately after you are paid, and save it. What’s left over is your budget for the month.

This is quite different from the strategy most of us apply, which entails saving at the end of the month, whatever we have left over.

More detail

So most of us have fixed bills, and then there’s what we spend on living, food and clothes for example, the rest, presumably, we spend on having fun. The odd meal out, a trip to the flicks, or whatever it is that passes for fun in your world. Whatever is left, we save.

And if you are super self-disciplined such an approach may work. But few of us are.

Paying yourself first entails setting ourselves a budget for the month, allowing a small buffer, and then saving the rest before we start spending.

Nudge

There is another way of looking at; we nudge ourselves into saving.

The famous book of that name, by Richard H. Thaler and Cass R. Sunstein regales the story a young Dustin Hoffman living with an equally young Gene Hackman — both budding actors, struggling to make ends meet. Hoffman dealt with the challenge by using different jars. A jar for rent money, a jar for utility bills, a jar for food, a jar for money to be spent on going out. On one occasion Hackman asked his flatmate if he fancied going out. Upon checking the appropriate jar, Hoffman found it was empty and asked if he could borrow some money. “But you have got plenty of cash,” said an incredulous Hackman, looking at some of Hoffman’s jars brimming over with money. “But,” replied the sensible Hoffman “the going out jar is empty.”

These days, in the age of contactless card payments, few of us put our cash in jars. But there are banks, such as Monzo Bank that gives us detail on how much we are spending: updated via our smart phones in real time. We may not have physical jars stuffed with cash — but we can apply something that is close to the virtual equivalent.

Beware

But I have a warning. Set yourself realistic targets — don’t try and save more than you can afford, such that you have to dip into savings before the end of the month. That way lies disillusionment, and you may give up.

Here is another warning, don’t use your equity portfolio as a bank account, something to draw down upon every time something unexpected happens. The time to sell equities is when market conditions suggest it is a good time to sell, not when you need cash. Such an approach can lead to disaster.

And there is one other point — saving a set amount each month is not for everyone, and it can be especially hard in these days of job insecurity. For some people, income fluctuates wildly from one month to the next. Pay yourself first can be a good strategy, but set realistic targets.


All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

See what else we have to say