Musing 4: Pay Yourself First

MUSING 4: PAY YOURSELF FIRST

It is a great liberating feeling when you start earning, with money flowing in to your hands for which you are not accountable to anyone-except to yourself. And that’s the reason I’ll discuss this amazingly simple, yet profound concept-Pay Yourself First in the initial musings itself. This concept has been beautifully put together by George S Clason in his classic book on personal finance- The Richest Man in Babylon; a book published in 1926 but still mint fresh in it’s simple yet insightful teachings. This concept has been further elaborated upon by many authors including Richard Bach in his book The Automatic Millionaire (both these books are available on you tube as audio books which one can listen to while commuting for work, during workout at gym or during morning jog-I have extensively used this dead time to enrich myself with wisdom of these and many other masters, for free). You may well ask as to why someone should teach you to pay yourself first when you are in fact being paid by your employer on 01^st or some other date of every month. While that is true, but ask yourself, are you really paying yourself first when you receive your paycheck?

          To begin with, the Government takes its share from you in form of taxes even before you receive your pay, followed by your employer in form of deductions as applicable to your line of job. And if that were not enough, you pay to your House owner for rent, gas station for filling fuel in your vehicle, Pizza Hut for the Pizza, H&M for your clothes-the list is endless. Where, in all these payments, have you paid yourself-not first I guess? The fact for most of the people is that, by the time they are through with paying everyone else, there is nothing left for paying themselves.

          Pay yourself first concept envisages that you set aside and invest a pre-decided percentage of your pay for your own future, before anyone has access to your money. If you do it smartly, you would end up saving part of your pay what the Government would otherwise have taken in form of taxes (We will tackle taxes in detail in subsequent musings). Secondly, what does not come into your hands at all, is not missed. So, the “pay yourself first” part of your pay will be notional to you and you will learn to manage your expenses within rest of the available money.

You might ask that if you are not even getting to use that money now, how that can qualify as paying yourself. Valid question, but always remember this money is being kept aside for you and your family’s future and not for anyone else. All savings/Investments you do today are a current sacrifice which will pay you handsomely later, especially when your earnings would have dried up and requirement of medical and other old age expenses gone up. In a way, by your diligent and systematic investments you would have created a “money machine”[1] which will generate a perennial cash flow and ensure that you don’t have to work and yet get paid in your later years.

How do you go about doing it? First up ask your employer about Employee’s Provident Fund (EPF) or other Provident funds and contribute maximum allowed to it. In many cases, the employer matches your contribution, so you get additional free money as investment. The interest earned is also tax free. Secondly, plan all the Systematic Investment Plans (SIP) of your investments, be it for retirement, children’s education etc. to be debited on 01^st of the month itself. Thirdly, use all the means available towards tax saving (just note sections 80 C, 80 CCD and 80 CCD (1B) of Income Tax Act for the time being, which allows you to save Rs 2 lac towards taxes)-EPF, Public Provident Fund (PPF), National Pension Scheme (NPS) et al. Since all these deductions towards your tax exemption and investments are taken out either before you receive your pay or alongside it (remember 01^st of every month for SIPs?), you will be forced to manage your expenses in the balance of the pay.

          Next logical question to ask will be how soon after one starts earning should one start paying himself first? After all, as one gets the first pay check, there is a lot one wants to do. The swanky bike, the sleek smart phone, taking your friends out for dinner or buying gifts for your parents, siblings or girlfriend, all (legitimate) reasons, will be jostling for your mind space and which will delay your paying yourself first, may be just for  couple of months. Nothing very alarming-but few things will happen, firstly, you will get comfortable with all the money coming into your hands and any cut in that money, even to pay yourself will appear a deprivation. Secondly, the couple of months will quickly get converted to couple of years and you will end up losing the all important power of compounding.

          You would remember our protagonist, Anshreya from previous chapter? Well she has decided that she will delay her “Pay yourself first “ strategy for a year, by which time she will be able to meet all her obligations, as we discussed earlier. Her take home pay is Rs 50000 and she very religiously starts to save 20% of that after one year of her starting to earn. Now all other parameters remaining same as we discussed earlier, how much will be her nest egg at retirement-Rs Eight and a half crore, pretty sizeable, right? But take a pause and reflect upon what was her nest egg in the previous example- Rs Nine and a half crore-yes she is poorer by Rupees One crore at retirement because she did not start paying herself first, from her first paycheck onwards and delayed it only by a year.

          Does this mean that life, after one starts earning has to be a drab and dreary affair where one can’t have any fun? Absolutely no-one’s life has to be in a beautiful balance where all the wants and needs are equally satisfied. So there is a place for Parties, smart phones and gifts, alongside savings, one just has to prioritize. We will tackle these issues in forthcoming musings. And finally, the BIG question-how much should one pay herself first? Well, the originator of this concept, George S Clason put a figure of 10% to it. Is this figure still valid? We will find out as we go along.

          Despite all the Gyan (wisdom) that I have given you, starting to save from the first paycheck may still be a painful affair. I will strongly recommend you to watch a short movie on you tube which explains the concept of “Save more Tomorrow (SMarT)”[2]. The concept is evolved by Shlomo Benartzi from University of Chicago, and revolves around the fact that we all find starting to save today too painful but won’t mind doing so from next month or next pay raise. It is a short 18 minutes movie. Do watch it. The link is provided below.

save more tomorrow

Key Chapter Takeaways

·        Pay yourself first is not depriving oneself of  good times in today; it is an insurance for guaranteed good times in the future by creation of a “money machine”, which will keep paying you without work.

·        The strategy has to start from first paycheck onwards, lest one gets comfortable with that additional money and increases expenditures.

·        One has to establish a Spending-Investing Balance (SI Balance, hereafter) in life because with that balance all the needs and wants of life can be fulfilled. SI balance, incidentally, is the very next musing.

·        Please read/listen to “The Richest Man in Babylon” and “The Automatic Millionaire”, both wonderful books on personal finance. Also see the video on “Save more tomorrow” on you tube. The links are provided below. I’ll keep sharing more such resources with you as we move along.

The Automatic Millionaire

The Richest Man in Babylon

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[1] Robbins Tony, Money- Master the Game.

[2] ibid.