The most popular money management tip is to “pay yourself first” — that is, to save automatically and thereby insure that you really do save.
The reason why this advice has become so widely accepted is that most people find little appeal to the idea of saving money. If you think of saving money in much the way you think of eating your least favorite vegetable, it probably is true that making saving automatic will increase the amount you save.
There’s a downside to the “Pay Yourself First” strategy, however. Pay-Yourself-First Saving is forced saving. Pay-Yourself-First Saving is a money management approach for those who don’t want to devote much thought to money management.
Passion Savers are seeking to win their financial freedom early in life. Those seeking to win their financial freedom early in life need better money management strategies than the money-management-on-autopilot “Pay Yourself First” approach.
My best money management tip is to pay yourself last. That is, make a decision as to how much to save only after examining the pros and cons of spending and saving and determining which money allocation choice offers the most life enhancement for someone in your particular life circumstances and pursuing your particular life goals.
Saving is not always a good idea. You need to pay yourself last, only after assessing the competing value propositions of spending and saving, if you are to save in those circumstances in which saving offers the better value proposition and spend in those circumstances in which spending offers the better value proposition.
Consider the money management tips set forth below to gain an ability to distinguish the circumstances in which it makes sense to save and the circumstances in which it makes sense to spend.
Money Management Tip #1 — By saving significant amounts of money when you are young, you allow yourself to tap into the income-generating power of your savings to a far greater extent than you would be able to if you did not begin to save significant amounts of money until you were older.
Say that you are going to save $1 million before retiring at age 65. Say that you can generate a 4 percent real return on each dollar you save.
Imagine a theoretical possibility in which you saved the entire $1 million on the last day of your working life. You would obtain the benefit of $40,000 of earnings that you would not need to work to produce for as many years as you lived beyond age 65 (perhaps 20 or 30 years).
Now imagine a theoretical possibility in which you saved the entire $1 million on the first day of your working life. You would enjoy the buying power provided by $40,000 of earnings from the time you graduated school. If you adopted frugal money management habits, you would not need ever in your life to work for money!
Your personal circumstances will fall somewhere between those two theoretical extremes. You won’t have saved all that you are ever going to save on the first day of your working life and you won’t be able to save everything you need to save to be able to live without working for money if you wait until the last day of your working life to begin saving. The most important money management choice before you is to decide where on the spectrum of possibilities between the two extreme hypotheticals your personal money management strategy will place you.
To the extent that your money management practices cause your own situation to more closely resemble the save-it-all-early scenario, you will be able to live at the same level of comfort over the course of your life without generating as much income from the work you do.
Money Management Tip #2 — There’s a compounding returns phenomenon that applies to spending.
Those arguing in favor of the “Pay Yourself First” maxim often point to the compounding returns phenomenon as a big benefit to automatic saving.
The compounding returns phenomenon is real. Saving when you are young really does provide an amazing long-term benefit.
What often gets missed by proponents of the conventional money management strategies is that spending provides compounding returns too.
Say that you elect to spend money that might otherwise have been saved to travel and thereby to learn about foreign cultures. That learning experience provides you benefits throughout your life. It might help you get a job that you otherwise would have just missed out on. In cases like that, the financial benefits of spending when young can be great indeed.
Money Management Tip #3 — There is a point of diminishing returns to the life enhancement provided by spending.
When you haven’t had anything to eat for twenty-four hours, a hamburger tastes mighty good. When you have just finished your second quarter-pounder, the idea of unwrapping a third holds little appeal.
Each dollar of spending does not provide equal value. Some dollars provide an outstanding value proposition. Some spending adds little to your enjoyment of life.
Some spending even detracts from your enjoyment of life. Did you ever force yourself to go out to eat at a fine restaurant that you really were not in the mood to go to because it seemed an appropriate way to celebrate a special occasion? In those circumstances, you often find yourself wishing that you could just eat at home in front of the television, where you wouldn’t have to deal with parking troubles and a waiter that takes too long to bring your order and all the rest that goes with a bad dining experience.
When you pay yourself last, the goal is to spend up to the point at which one more dollar of spending yields less life enhancement than one dollar of saving, and then save the rest. There is no saving percentage that always works. In some circumstances, the best saving percentage is 5 percent of income. In others, it is 15 percent. In still others, it is 25 percent or more.
Money Management Tip #4 — There are certain kinds of fun you can only have when you are young.
If you miss out on experiences best enjoyed by the young while you are young, those experiences are lost to you for good. All the money in the world won’t allow you at age 50 to buy an opportunity to bond with your friends from college on a camping trip at a time of life when you are all facing similar excitements and fears over making your mark on the world.
There are some life experiences that cannot be valued in dollars-and-cents terms. Give those up due to a misplaced desire to “Pay Yourself First,” and you have made a poor money management choice, in my view.
A recent thread at the Vanguard Diehards discussion board explored both the risks and rewards of the popular “Pay Yourself First” money management tip and the “Pay Yourself Last” alternative endorsed here.
Money Management Tip #5 — There’s value in the peace of mind purchased by saving effectively.
Saving yields not only an income separate from the income you earn from the work you do. It provides peace of mind. Savers are in control of their fates to a greater extent than are those who fail to save.
The fact that it is hard to put a dollar value on the peace of mind gained by saving does not mean that that peace of mind does not offer as much or more life enhancement as do the goods and services you could have spent the same money on instead.
Money Management Tip #6 — Saving becomes a habit for those who engage in it regularly.
One big benefit of the “Pay Yourself First” approach to money management is that forced saving permits the saver to experience the joys of saving for himself or herself. We all regularly experience the joys of spending because we must do so if we are to eat and to visit doctors and to enjoy indoor comfort on the hottest of summer days. Those who don’t save don’t realize how much fun it can be. If they did force themselves to save at least a little, they probably would enjoy saving enough that saving would become a habit and in time they would come to save more.
Money Management Tip #7 — Accumulated savings comes in handy in a crisis.
Much of the happiness you enjoy today depends on your ability to continue earning the income you earn from the work you do. But your job is not secure in the modern-day economy.
Saving opens up options that permit you to deal with unexpected developments in effective ways. Savers are better able to start their own businesses. Savers are better able to take jobs that pay less but offer more in the way of personal fulfillment. Savers are better positioned to be able to remain out of work long enough to obtain a job offer that is truly appealing.
Money Management Tip #8 — There are risks attached to saving.
We are often warned of the risks of not saving. Fail to save and you may not be able to provide for yourself when you are too old to work.
The risks of saving are not often noted. But they are real. Save, and you give up opportunities to do the things you could have done with your life had you spent the same amount of money instead.
Most of us earn larger incomes in our 40s and 50s than we do in our 20s and 30s. Presuming that there is one level of spending that provides us the greatest possible life enhancement, an argument can be made that we should be spending more than we earn in the early years of our careers when we do not earn enough to finance that level of spending from our earnings, and that we should be spending less than what we earn in later years of our careers when we earn more than enough to finance that level of spending.
I don’t advise young people to acquire large amounts of debt so that they can live at age 25 the lifestyle that they will be able to afford with the salary they earn 30 years later. But I do think that the possibility that you will earn more as you age is a factor that should be taken into account when crafting a Life Plan.