Use the superpower of the pay-yourself-first method to spend, save and invest.

📚 Table of Contents

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• Introduction
• Using buckets
• Tracking expenses

Introduction

Pay-yourself-first is one of the golden rules of personal finance that builds up a habit of saving and investing. This concept is similar to a loan where the lender deducts the EMI automatically every month. There are penalties for missing a payment. We can use the same technique for savings and goal-based investing.

The main benefit of paying-yourself-first is that the money is moved out of reach before discretionary expenses start. It is like a salary that you are paying to your future self.

Expenses = Income - Investments, i.e. money is spent only after money is saved and invested.

Based on how your income is structured, either regular from salary or irregular from your profession, business or freelancing, you should

• Fix a minimum percentage value like 30%. The more you can allocate, the better it is for the plan to work.
• As soon as you get income, transfer that 30% money to a separate investment account (automate this for salary income via an NEFT instruction). The process will fail if you do not follow this step.
• Whenever income goes up, bump up that percentage
• Maintain the percentage contribution as much as practical. Do not lower it.

Using buckets

Use your income to fill expense buckets in this order:

• Bucket 0: Monthly expense buffer to cover mandatory expenses for a few months to smoothen the budget. Bucket 0 is well suited for folks with irregular income (covered in more detail here). Salaried individuals can skip it since their salary will cover all monthly expenses
• Bucket 1: investment fund: invest as soon as this bucket has money as per goals
• Bucket 2: Emergency fund: hold 6-12 months of expenses and all EMIs in 50:50 proportion in a savings account and liquid mutual fund. See this detailed post for discussion of the emergency fund.
• Bucket 3: Sinking fund: This is for insurance payments, trips, festival shopping, white-good replacement etc. Estimate the yearly value for all of these and target saving 1/12th every month in the bank. This is discussed here in more detail.
• Bucket 4: Fun fund: save money here for things like entertainment, trips, gadgets and experiences. Allocate what you want for this bucket and try to stay within that limit.

Tracking expenses

For budgeting to be effective, you should track expenses via apps like Hello Expense, YNAB, or anything (even a spreadsheet or physical diary) that allows you to note down expenses as you make them. Use the Pareto principle (ensure that the biggest spends and recurring smaller spends are both captured). This way, it is not necessary to track every rupee spent. The target here is to be more or less accurate regarding your estimated and actual spending. For completeness’ sake, we will briefly touch upon debt payment. There are two methods for paying off multiple loans. Of the total amount of money being allocated for debt payments every month, call it D rupees per month:

• debt avalanche method: here most of the payment (out of D) is made to the highest interest loan first and for the rest, only the minimum payment is to be made
• debt snowball method: here most of the payment (out of D) is made to the loan with the lowest outstanding balance first and for the rest, only the minimum payment is to be made If there is only one loan, you need to pay at least the minimum amount monthly. We have already covered home loan payment here. We have discussed overall debt repayment in more detail here.

Note of caution: Pay-yourself-first works only if you decide to aggressively implement the practice with a percentage contribution as high as possible, preferably via automated transfers. If you follow thumb rules that say “save %x of your income”, there will be two problems:

• it will give you a target that seems easy to achieve (for example, the 30% that is given above)
• provide a false sense of security that not be sufficient for long term investment goals

So instead of fully dependent on thumb rules, adjust the percentage figure of pay-yourself-first suitably for your financial condition. If you need an exact calculation, here are some posts that can help you:

• What percentage of my salary should go towards retirement?
• Goal-based investing will show you how much you should have saved at 30,40,50 and retirement