April 23, 2021

How paying yourself first can grow your savings

How paying yourself first can grow your savings

💯💯💯 "If our entire retirement and economic freedom is left up to our decision making and our self-discipline, only, then we will inherently fail, we will never build up savings, we will never contribute to retirement, and we will be forced to work until the day we die."


Saving money is a goal for everyone, but few seem to have a system in place to do it.  When left up to our own motivation or self-discipline, we find ourselves highly unreliable.   The system in which we use is what will allow us to grow our savings for big life expenses and retirment.  In today's episode, I'll be talking about the what, why, and how of paying yourself first.  

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Transcript

Michael Der  0:02  
You're listening to Artrepreneurs, a podcast that inspires photographers and visual artists to live their best creative lives. My name is Michael Der and I am a full time photographer with nearly 10 years of experience in the freelancing world. And I'm sitting down with an amazing community of visual artists to talk about process, business, and the lessons that have helped them grow. So let's get to it. Artrepreneurs starts right now.

All right, what is up everybody? Welcome back to another episode of Artrepreneurs, I'm so thrilled to have you guys here with us. I was recently thinking about what I wish I knew when I was younger when I was 18, or 20 years old. And after thinking about it for a little bit, I realized that if there were just one area of my life that I could course correct. If there's one thing that I could go back and change, it would be to start my financial plan in my teen years. And that's really it, it wouldn't be to travel the world in my 20s, or ask out my college crush, or even take back the actions that got me fired from my job. No, if I had just one redo, you would really just be to implement the principles and systems that I have now back when I first started earning money. And to me, the most transformative one is also the most basic, this principle is referred to as paying yourself first, maybe you've heard of it, maybe you haven't, it doesn't require tremendous knowledge on finance, or economics, which is why I love it. It also doesn't require a high net worth or high annual income. So what I love about it is that it feels very much like this ground level strategy in economics, it can be applied to someone with a $20,000 income and no financial education just as easily as it could be to somebody that makes six figures, and has a degree in finance. Now, the basic concept of growing your savings is actually very simple. The idea is to spend less than what you earn. That's it, it's the same notion as losing weight. If you want to lose weight, all you have to do is really consume fewer calories than you physically expend. And so there is no secret philosophy on what it takes to save money, you know what it takes, you just may not have a system in place, and that's where most people fail. Now to preface every person's home economy situation isn't going to be the same your priorities, your goals, your income, your spending habits are going to be very much unique to you. So it goes without saying that I am no financial advisor, I certainly make no claims to be able to transform anybody's wealth. My goal here today is to merely explain how paying myself first has allowed me to save money in a very high cost of living area like Southern California, while also on a relatively low to moderate-income. So this episode is going to be broken down into three basic parts. The what, the why, and the how, part one, the what. So before we define paying yourself first, we have to define paying yourself last. And the average American investment strategy goes something a little bit like this. Let's use jack and jill as an example. When jack and jill receive their paychecks, they use that money to first pay off bills, pay off debts, and then pay off essential expenses. After that they pay for personal ones like entertainment, clothing, and dining out we call this discretionary expenses. And then the last step is whatever's left over. That's what jack and jill are going to use to fund their retirement and their savings. That's a typical example of paying yourself last. paying yourself first, however, is sort of the inverse of this process. So imagine jack and jill elect to set aside a percentage of their income to their savings or their retirement. And then they paid their secondary bills like their discretionary expenses last. So to sum it up, before you pay rent before you pay your electric bill or your car insurance, you're going to ensure that you get paid first, part number two, the why. Okay, so the reason why paying yourself first is so successful is because it circumvents our purchasing impulses. And it really guarantees that we're going to get our portion regardless of what we buy during the month. The reality is if it's left to us, if it's left to our own devices, what is typically going to be left over after paying for all of our expenses, all of our needs would actually be $0 insurer, if you want to start calling out things like poor wages, growing inflation rates and the insanity of student debts, then go right ahead. There's certainly something to be said about the rising cost of living. But that's really not what is preventing us from saving money. And that's ultimately a completely different fight altogether. What most people don't want to hear is that they're undisciplined with their money. But I'm here to tell you that our human nature prioritizes things that are in the here and then now, it's very difficult for us to conceive of the importance of retirement savings or big life expenses down the road when they're just not on our doorstep. Here's a great quote I pulled from David Bach's financial book called the latte factor, and he explains how financial discipline is almost guaranteed to be unreliable. It's hilarious. He states the government had this figured out years ago, up to World War Two all of us good Americans collected our paychecks in full and didn't pay Uncle Sam his chunk to the following year. The problem was we didn't plan so well. We did.

budget. So they tried spending a bunch on campaigns to teach us how to budget so we could pay our taxes, and son of a gun. That didn't work either. So Uncle Sam said the heck with it, and set up a simple system that pulled out his chunk automatically, before it even reached our undisciplined little hands. And what do you know, it worked. Every time we earned $1, Uncle Sam got paid first. So what that quote tells me folks is that if our entire retirement and economic freedom is left up to our decision making and our self-discipline, only, then we will inherently fail, we will never build up savings, we will never contribute to retirement, and we will be forced to work until the day we die. That my friends is the why. Now let's jump into the house, which for me is comprised of three basic components or three steps. Step number one is what I call the piggy bank phase. This is effectively where you set up multiple bank accounts or buckets that you're going to contribute to step number two is determining a fixed percentage of your income that you're going to assign to those buckets. And lastly, the third step is to find a way to automate that process so that your human impulse doesn't actually come into play. So let's break this down step by step. Step number one, separate your piggy banks. Let's imagine for a second that 10-year-old jack wants to save up for some comic books and baseball cards. And he has a piggy bank that he contributes to every time he earns an allowance or receives birthday money from grandma, grandpa, fast forward a month or two and all of a sudden, he has 20 whole dollars. So Jack's pumped up, he decides he's going to take his $20 and go to the comic book store, first spend $10 and then go to the baseball card store afterward and use the remaining 10. So the question is, do you think jack has the discipline to cap his comic book spending at $10? So that he has $10 to spend at the baseball card store? Or do you think he's more likely to spend all of it at the Comic bookstore, leaving him with no money left over for baseball cards? Well, there's no way to know for sure, but I'm going to guess that little jack spends the majority of his money at location one. This is what a lot of us are guilty of, we don't really allocate our budget for other things that we want or need. Now let's fast forward a couple years, maybe jack has grown up a little bit. He wants things like a bike or painting supplies were a video game. How would you teach them to save money for all of these things? Well, one simple way he could do this is to have multiple piggy banks, one bank for comic books, one bank for baseball cards, one bank for art and painting, etc. And each time he earns an allowance, he splits that money contributes to all of his savings. Each bank might grow slower, but it separates the money and it prevents jack from taking money that is for something else. This is what I do. I just don't label them the same way. So I'm going to keep it simple and give you three accounts or buckets that I use to separate my income. So the first account that I'm going to set up is one that I'm going to label taxes. Now I know what you might be saying that, Mike, this is not paying yourself. First, you're paying Uncle Sam first. Well, technically you're 100%. Right, you got me there. And the reason why it makes us the first bucket is because 1099 workers do not get taxes withheld, like traditional employees. So ultimately speaking, everybody pays Uncle Sam first, freelancers just have to be proactive about it, I just don't want you to put yourself in a position where you're spending money that you don't have, which is a rookie freelancing mistake. So bucket number one is taxes. bucket number two is my emergency fund. This, to me is the first real step of paying yourself first, if you think you won't have emergencies come up, then you're setting yourself up for disaster, there's always something that can and will go wrong. Maybe your transmission blows, maybe you have a medical emergency that you have to pay out of pocket. Or maybe you lose a couple jobs. In fact, most of my emergency fund is for unexpected slow seasons, it basically acts as my payroll. bucket. Number three is retirement. This is the big one because it's commonly overlooked by young people because retirement is so far away. But you may be living like 30 years after retirement age. So it helps to start using compound interest on your side and build a nest egg for your future. For some it might be a 401k or an IRA. Or maybe it'll be something like cryptocurrency or the stock market, whatever it is, if you don't have anything set up just yet, just start putting money aside. And then you can research what vehicle you want to invest in later on with your family and your advisors. And if you really want to get deep on this, you can create more accounts to save for future expenses. I mean, I did this for my wedding, I have one for my first home, maybe you want to replace your car in two years, this is a good way to do it. But before we start creating more and more accounts, let's just start with the basics. In my opinion, freelancers need to have an account for taxes, emergencies and retirement first. Now let's talk about the percentages. The tax bucket is basically non-negotiable, whatever your tax rates are, that's what you should be setting aside every paycheck for me I owe about 27% in taxes, which is a breakdown of 15% for self-employment tax 10% federal and then 2% California state. So to make that math super easy, I just rounded up to 30%. So every paycheck that I do receive I transfer 30% to My Tax Account. For example, if I make $1,000 I'm transferring $300 to that bucket, because in no way do I want to accidentally spend that $300 it's not mine. This way when each quarter comes around and I have to pay taxes. I have the money saved in that account specifically for that occasion. For me my

Emergency Fund and retirement funds are both set at 10% each. So if we take that $1,000 paycheck As another example, each account is going to get $100 contributions. And this part is totally up to you and your situation, whatever you deem necessary. For those who are trying to tackle a lot of debt, for instance, you may want to be conservative in these percentages so that you prioritize killing off your student loans or your car payments or your credit card purchases. For those who are maybe living rent free, like recent graduates, this is an excellent opportunity to get aggressive and maybe max out your retirement contributions, and really bulk up a six-month to a year-long emergency fund. So with all that in mind, the final and most important phase of this process is to try and make it automatic to remove yourself from the human equation. Now, for me, paying myself first is an actual life principle. So I have no issues going into my bank account and manually transferring money every paycheck, it takes me about two minutes every time. But for those who are a little bit more forgetful, or maybe view this as too much of a hassle, you may want to determine a set dollar amount instead of a percentage, and have that automatically transferred to your other accounts each month. Now, one last little caveat here, depending on your bank, they may charge you a certain amount of money to open up new savings accounts. And they may even have a minimum requirement for each one. To me, this defeats the purpose and completely D incentivizes this method. So I prefer using online banks that have no startup costs, no minimum requirements and minimal fees. Now, I'm not going to endorse any one particular bank. But there are plenty of options out there that will offer you more benefits than brick-and-mortar banks. And then you could research them on your own accord. The savings rates at these banks used to be really good close to about 3% or over. But those days are pretty much done. The rates have cut down substantially. So you're not really looking to grow your money through traditional AP Why? instead you're looking to grow your money through organization and systematic contributions. That's the benefit. So while some people may say savers are losers, I really disagree. In this context, you need to set money aside for taxes, you need to have liquid cash for emergencies. And if you don't have a retirement vehicle set up just yet, you should be setting money aside now. So that when you do set something up, you have your first contributions ready to go. Ultimately, whether you use the system or not is of no consequence to me, but I do urge you to see the benefit. In this principle. If you pay yourself last, you might have some money leftover for savings. But if you pay yourself first, you guarantee that you will. Additionally paying yourself first will inherently curb lifestyle inflation because now you will have a built in discipline on living on what's left. I've already told you that I live off 50% of my paychecks. That doesn't happen without a system. Folks goals are not enough when it comes to money. Winners and Losers have the same goal. Your goal will not be met without a system when there is none. Our savings growth is dependent entirely on self discipline, and prudent decision making something that has proven to be inconsistent and unreliable. As Benjamin Franklin once said, failing to plan is planning to fail. So we need to recognize that no matter how good a photographer we are no matter how many hours we devote to our craft. If we don't make the right choices, we will always be tied to work in quantity over quality. I hope this gives you food for thought everybody, this principle has been one of the most important financial lessons that I have learned in my life. If you are interested in a little light reading, I do recommend a couple books that discuss this concept in depth. The first one I actually referenced earlier in this episode is called the latte factor by David Bach. The second book I'd recommend is called The Richest Man in Babylon by George claisen. Both are very easy reads and way more articulate than I am when it comes to discussing money. So be sure to check those out. I think you will find those books helpful in sculpting your view on income and how to approach wealth building. And as I bring this episode to a close, I do have to thank the entire Artrepreneurs community for your amazing five star reviews, your emails, your DMS, your phone calls. Thank you so much. I couldn't do this show without the community's love and support. So thank you again. My name is Michael Der and this is Artrepreneurs season one. See you next time everybody and have a great week.

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Transcribed by https://otter.ai