When I decided to follow the principle of paying yourself first I managed to exponentially increase my savings rate from around 10% of my income to 30% of my income. I discovered this principle from a book titled the Richest Man in Babylon. The book is made up of short stories or parables which the author uses to teach the reader a set of finance lessons.
Prior to following the principle of paying yourself first, I would receive my salary for the month and immediately pay bills- rent, mobile, broadband and groceries. Then I would pay Sony and Netflix for entertainment. Through the course of a month I dwindled down my cash through frequent spontaneous spending on lunch or takeaways. And whatever amount of money was left over is what I would save.
Trying to save this way meant my savings rate was not consistent. Over a six month period my savings would read something like this: January savings +£100.00, February savings +£50.00, March savings +£73.00, April overspend -£200.00, May savings +£65.00, June savings +£35.00, so in my mind I thought I’d saved quite lot, but what I didn’t include or didn’t realise was the one month where I spent close to what I managed to save over five months. As a result, I was moving sideways instead of moving closer towards a total savings goal. However when following the principle of paying yourself first, I found you are always making progress, every time you execute the principle, you will always be further head compared to the previous month. The way I interpret this principle is, the money you get paid at the end of each month only came into existence through you exchanging your time and skill set at a job or business. Therefore, paying yourself first is simply acknowledging this.
In order to execute the principle of paying yourself first, I needed to change other aspects of my savings behavior. The first thing to have in place was a savings target. In my case, my target was £6000.00. Additionally I gave a personal reason as to why I wanted to save £6000.00. And the reason was because I wanted to have a contingency fund in place before investing in property and the stock market. Something else I did, which is not mandatory, I decided to challenge myself by saving 30% of my income instead of the 10% suggested in the Richest Man in Babylon.
I then took action, I opened separate accounts for my income and my savings. I did not allow my income and savings to remain in the same account. To make this easier, I made use of standing orders. On the same date I received my income, 30% of my income would automatically be transferred from my ‘income’ account into my separate contingency account.
Today I'm sharing how I split my income across different types of accounts and the purpose of each account.
Long Term Savings & Investments
1. Group Personal Pension Plan - The pension pot is the first place part of my income goes too. The money in this account is used for the purchase of company stocks and shares with the aim of providing a 'retirement' income.
Medium Term Savings & Investments
2. Help to Buy ISA (Individual Savings Account) - This account is used to save for a property deposit. The great thing about this account is the government payment bonus received when you're in the process of buying a property. At the time of writing, the account rules allow a maximum monthly deposit of £200.00 per month.
3. Regular Saver - Due to the savings restrictions of the Help to Buy ISA, I use a regular saver account as a second place to save money for property deposit and the associated purchasing costs. Compared to a standard savings account, a regular saver usually pays a higher interest rate in exchange for a commitment to deposit a certain amount of money each month.
4. Stocks and Shares ISA - As the names suggests, this account is used for investing in the stock market. The primary use of this account is to provide future retirement income. However, unlike the group company pension account where you have to be age 55 to start withdrawing the income without penalty, I'm free access the money in my Stocks and Shares ISA when I need too. As a result, I may use the some of the funds for the purchase of property. I wrote a basic introduction to stock market investing in this post.
5. Tax Free International Investment Account - Similar to the stocks and shares ISA, I use this account for investing in the shares of companies outside of the US and UK stock exchanges. And like the ISA, the earnings made in this account are exempt from capital gains tax.
Short Term Savings
6. High Interest Current Account - This account is used as an emergency fund. I keep 6 months worth of essential livings expenses in this account. The purpose of this account is to prevent or delay my need to borrow money during a time I need to make an unexpected purchase or a period I'm not earning any income. This cash reserve is also in place to prevent the need to sell any of my current or future income producing assets such as stocks or rental property.
7. Current Account - Once my salary is in this account, I only keep the amount of money needed for cash payments. This includes rent, pitch hire for football with colleagues, donations and life insurance. I use a rewards credit card for all my other monthly bills and expenses (council tax, broadband, sim only mobile, train tickets, groceries, music and gaming subscriptions).