We have all heard that paying yourself first is the best way to become wealthy in our society. Whilst we all know the merits about paying yourself first, many people do not now exactly how much money to set aside to pay themselves first. So is there a magic number? You hear people asking themselves this question all the time How much do I need to pay myself first?
So here is my formula on how much you should pay yourself first. You don’y have to agree with it but just have a look at it.
Whilst I know everybody is different and people have different circumstances, I am just going to give you the generic formula.
- Dead Broke Approach – If you want to live a life where you are dead broke, stressed, living pay check to pay check, and want to consistently worry about the future, then don’t pay your self first at all. That way, you have no savings and investments. If you really want to be broke, the best thing to do is spend more money than you make and be in credit card debt. Whilst this sounds silly, it is the situation faced by many today. People without realising spend more money than they make and rack up credit card debt and then wonder why they are always broke. So if you don’t pay yourself first, you are following the dead broke approach.
- Poor Approach – If you want to be poor, just spend everything you make. It is that simple. See, if you make £50,000 a year and spend £50,000 a year, you are still poor. Just because you are making a lot of money does not mean you will eventually be wealthy. You need to have good saving habits too. This is common in big cities like London where people earn a bucket load of money but spend just as much leaving them at the same position they were a year earlier. This what you call ‘Rich – Poor’. They seem rich, but they are actually poor. They save nothing!
- Middle Class Approach – If you want to be a middle class person, you want to pay yourself first 5% – 10% of your gross income. So say your gross income is £40,000. So 5% would be £2,000 and 10% would be £4,000.
Whilst saving £4,000 a year is a good start, if you want your money to work for you and earn its own money on your behalf, you need to invest the money. So if you open a Stocks and Shares (ISA) and invest your money in a plain vanilla index fund like the FTSE 100, FTSE 250 or S&P500 which has historically produced a return of 8% on average, after 30 years of investing £4,000 into the index fund every, you will have a grand total of £529,634.
- Upper middle Class – If you want to be upper middle class, you want to pay yourself first 15% of your gross income. So 15% of £40,000 would be £6,000.
Again, you can make your money work for you by investing it. As above, if you add £6,000 a year into an index fund which has a yearly return of 8%, you will have close to £800,000 after 30 years.
- Rich – If you want to be rich, you want to pay yourself first 20% of your gross income.
So 20% of £30,000 would be £6,000
By putting the £8,000 a year you saved into an index fund returning 8% a year, you will have £1,059,268 at the end of 30 years.
- Super Rich – You want to pay your self first at least 25% of your gross income.
So 25% of £30,000 would be £10,500
By putting the £10,000 a year you saved into an index fund returning 8% a year, you will have £1,324,085 at the end of 30 years. You have got to love compounding (LINK).
So the above is the approach you need to follow in order to determine how much you should pay yourself first. The formula took you from dead broke to middle class to super rich. here is the interesting bot about the above approach, its not a fluke how people end up where they do in society. When you look at the above approach and look at why some people are dead broke, it is because they are not paying themselves first. So if you have ever wondered how much of your income you need to save in order to become rich, just look at the above.
Think about people you know. Some people you know are dead broke. Some people you know are poor. You also know people who are middle class, upper middle class, rich and super rich. A lot of times people think that it is just a coincidence that people are rich. They got lucky. But you need to realise that most people do not end up wealthy through luck. They created there luck. You know have an approach or formula that you can use to create your own luck.
You may not like the formula. When many people read this formula, they get and or even angry. They think it is ridiculous. No one in their right mind can save 25% of their gross income. But here’s the thing, I don’t expect anybody to go from 0% paying themselves to 20% paying themselves first straight away. It is almost impossible to change all of your habits overnight. You need to start off paying your self first in small amounts. Start with something like 5% a year and then slowly increase this amount at the years go by.