Paying yourself first

There is perhaps no single piece of financial advice more frequently repeated than “pay yourself first.” And with good reason. It’s tough to grow savings if you prioritize all your spending needs and wants ahead of putting money away. While some of us fully intend to stash whatever is left at the end of each month, too often that leaves nothing to save.

This tendency to spend everything we earn is something governments understand well.That’s why they make sure they get their share—income taxes—before you even set eyes on your paycheque. Saving with the “pay yourself first” method follows the same principle. And this step-by-step guide shows you how to do it.

Step 1: Zero in on your savings goals

It’s easier to commit to paying yourself first when you know the purpose of your savings. Are you building an emergency fund? Saving for a down payment on a house? Are you hoping to pay for a wedding? Or fund your retirement? 

Perhaps you are saving for all of these goals, or different ones. The important thing is to understand why you are saving and to set aside these funds outside of your day-to-day chequing account, which should be reserved for bill payments and other spending money. Research by behavioural economists has shown that this act of “labelling” money for a specific purpose makes it easier to save because it creates a psychological hurdle to spending the money on other things.

Step 2: Determine how much you can save

This is perhaps the most challenging part of the pay-yourself-first process because you need to make sure you won’t end up in overdraft. There’s no sense setting aside a set amount in savings at the beginning of the month if it means you’ll run out money to pay for necessities such as groceries, rent or utilities before the month is over. 

Here’s how to figure out how much you can realistically save:

  • Write down your average monthly take home pay.
  • Subtract the average monthly cost of all your needs, including shelter, food, electricity/heat, phone, transportation, etc. (Note that purchases such as clothing and shoes are only “needs” if you are replacing items because they are worn out or your size has changed; otherwise they are “wants” and should not be included in this part of the calculation.)
  • This leftover amount is called your discretionary income—meaning you can choose to save (or spend) as much of this money as you like.

Say you have $800 each month in discretionary income. You might decide to allocate $300 for spending on wants (like fast food or restaurant meals, entertainment or clothing) and $500 to savings. Obviously, the more you dedicate to your savings each month, the faster you will reach your goals. 

Step 3: Earmark savings for each goal

Now that you know how much you can afford to save each month, you’re ready to decide how much money to direct to each of your savings goals. If, for example, you are planning a wedding for next year, you might choose to devote the majority of your earmarked savings to that purpose—at least until you have enough to fund the event. Once you reach that goal, perhaps you’ll decide to put half of those monthly savings toward retirement, and the other half into your emergency fund. Or perhaps you’ll set your sights on a home renovation, or a special trip. 

There are even some bank accounts, such as EQ Bank’s Savings Plus Account, with digital tools that let you create virtual “envelopes” so you can set and track each of your various savings goals all in one place.

Step 4: Automate the deposits

There are a couple of ways to make your savings payments simple and automatic. One is to set up a recurring monthly transfer from your chequing account to a high-interest savings account, as follows:

  • Log in to your online bank and choose “transfer funds” from the menu.
  • Input the amount you want to save each month.
  • Specify which account the money should be taken from (chequing) and the account you want it moved to (savings).
  • Select the date you’d like the first transfer to happen. It’s best for it to be shortly after payday, and as early in the month as possible. So, for example, if you’re paid on the 1st and 15th of each month, you might set up your transfers for the 3rd of the month. That allows enough time for your pay to clear, but very little opportunity to spend that cash before it is whisked away to your savings account. 
  •  Choose the frequency option “once a month”
  • Indicate an end date, or how many times you want the transfer to take place (for example, if you want your monthly savings to remain unchanged for a year, you’d choose 12 times).

Of course, you can always log into your account at any time to make changes to upcoming transfers. If an unexpected home repair or other emergency expense comes up, you can consider decreasing or temporarily holding off on your automated savings.

Similarly, you can—and probably should—increase the amount of your automated transfers to your savings account whenever you get a raise. That way you’ll make sure to set aside that extra money for your targeted goals rather than succumb to lifestyle creep.

If you’re paid by direct deposit, you could also ask your employer to deposit a specific portion of your pay directly into your savings account. Some people prefer this method because it takes an extra step—contacting your employer’s payroll department—to make changes to their savings plan, whereas they might feel it’s too easy to cancel or reduce their savings transfers via online banking. 

Step 5: Open the right accounts

Now that you’ve gotten into the savings habit, you can open the appropriate accounts to house those savings. For example, if you’re saving for a short-term goal like a wedding, a Tax-Free Savings Account (TFSA) is a good choice (if you have available contribution room) because you can withdraw the funds at any time without penalty and you won’t pay income tax on the interest you earn—which allows your savings to grow even faster. 

For retirement savings, a Registered Retirement Savings Plan (RRSP) savings or investment account is ideal, since your contributions are tax deductible—giving you even more money to sock away—and the interest or investment income on your savings will grow tax free until withdrawal.

A word of caution

The pay-yourself-first strategy only works if you are living within your means. If you rely on a line of credit or carry a credit card balance to fund your lifestyle, you won’t benefit from automated savings. While you might enjoy watching the balance in your savings account grow, the high rate of interest charged on your debt will wipe out any savings gains, and then some.

If you have outstanding credit card balances or other high-interest debt, you can still use the pay-yourself-first method, but your automated transfers should be made toward your credit card or other loan accounts rather than to savings. Once you’ve paid off the debt, you can then redirect the monthly transfers to your savings accounts.


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