Blog | Personal Finance

Pay Yourself First (But Don’t Save the Money)

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Why the rich don’t save money and the true definition of pay yourself first

A while back, I wrote about why high paid athletes go broke. In it I shared how many athletes go from rags to riches because they have a lot of talent, but unfortunately they don’t have any financial education.

This, of course, is not the case with all athletes. Many are smart enough to get mentors who help them make smart financial decisions. And many go into business and make smart investment moves with their money.

The quality of this advice, however, varies greatly.

Dallas Cowboy’s running back, Emmitt Smith, shared the best money advice that, ever got with CNBC. Not without his share of financial blunders, including buying a $100,000 car at age 20, Smith says that the best financial advice he received was from Cowboys owner, Jerry Jones.

“He taught me about finances with a simple statement,” said Smith. “He always said, ‘Have a big front door and a small back door. Take in as much as you can, and spend as little as you can.’”

In essence, Jones was advocating for saving, which is the traditional money advice many people receive. It perhaps works for athletes making millions of dollars, though it is still bad advice, but it doesn’t work at all for the majority of people struggling to make ends meet.

In short, savers are losers, and the rich don’t save their money. Instead they practice the pay yourself first principle, which is much more than saving. I’ll explain further.

If you want to be rich, don’t save your money

The traditional financial advice to save your money is a popular one. And, again, maybe for an athlete making millions of dollars a year, it makes sense. But for the vast majority of people, saving is not a way to get rich or stay rich.

In fact, for the vast majority of people, saving is a sure fire way to lose. Why? Because inflation often rises higher than the interest rates you’re paid for your money. So the whole time it’s sitting in your bank account, your savings is actually losing money.

To illustrate this let’s use a nice round number like $100. If you have that amount in savings with a 1.5%, an average interest rate banks give these days, you’ll have $101.50 by the end of the year. Unfortunately for you, the saver, inflation is around 2.3% as of this writing, so the same amount of things you could buy today for $100 will cost you $102.30. That’s a difference of $0.80. Multiply that over time, and you could be in for a big loss on the purchasing power of your money.

What’s worse, money is a currency. If it doesn’t keep moving, it dies. One sad thing about savers is that they never put their money to work for them, and because of this, they don’t become rich.

This is why rather than teach people to be savers, I teach them to be spenders—in the right way.

Rich is not how much money you make

What does it mean to be rich? Most people would say that being rich means having a high paying job and lots of nice things like cars, houses, and designer clothes.

But it’s not how much money you make that makes you rich. Take, for instance, the lottery winner who has lots of money but burns through it on all sorts of knick-knacks. There are plenty of stories about broke lotto winners. In fact, nearly one-third of all winners declare bankruptcy.

And as I mentioned at the beginning of this post, the same can go for young athletes who make it to the pros. One day they are broke, eating ramen for lunch and dinner, and the next day they are millionaires. Many of them simply don’t know how to manage their money.

But it’s not just lotto winners and athletes that don’t know what to do with money once they have it. Take a look at the findings of a recent survey of 7,000 people on their saving habits:

Of those whose incomes were less than $25,000, 38% had $0 saved, and 35% had less than $1,000. People who earned more fared better, but still reported low amounts of savings in savings accounts. Of those with incomes of $100,000 to $149,999, 18% had $0 saved in a savings account, and 26% had less than $1,000. And for earners of $150,000 annually or more, those numbers dropped slightly to 6% and 23%, respectively.

It may surprise you to see that those who are considered “rich”, those making over $100,000 a year in salary, save nearly as little as those who make $25,000. It does not surprise me.

The reality is that if you don’t know how to use money to make yourself really wealthy, you will generally spend to the level of your income. This is what I call the rat race.

Welcome to the rat race

When I created my board game CASHFLOW®, I did so to help people escape the rat race. The rat race is the cycle of poor financial habits that most people make in order to keep up with the Jonses (especially the Jerry Joneses!). Most people, no matter how much money they make, can’t escape the rat race. Instead, they increase their lifestyle spending to match their new income.

There isn’t a problem with increasing lifestyle spending. I like nice things as much as the next person. Rather, the problem is how that increase in spending is financed—mainly through a salary.

As an employee, most “rich” people are one bad economic downturn or disastrous decision by a company CEO from their own economic ruin. Unfortunately, we are in the midst of this right now with the Coronavirus crisis. Goldman Sachs is projecting that there could be as many as 2.25 million jobless claims from the crisis, “a spike so large that it, if it comes to pass, will ruin the scaling of future unemployment claims charts.”

One exercise I like to ask people to do is to list out every expense they have in one column and then their income in another. Then I ask them to cover the income column. “How long,” I ask, “Would you survive without your salary?” For most people this is a moment of truth…and panic. It’s their first insight into their rat race.

The reason most people don’t save, including the so-called rich, is that they don’t understand how to make money work for them. They are poor when it comes to financial intelligence.

The rich don’t cut expenses...they increase them

Unfortunately, most people’s initial reaction to the rat race is to cut their expenses. This is the advice from Jerry Jones that Emmitt Smith found to be so attractive: “have a big front door and a small back door.” This can work for a time, but the reality is that you can never cut all your expenses. And let’s face it, cutting the fun things out of your budget is a miserable thing to have to do.

Cutting expenses is what the poor do. The rich do not cut expenses. Rather, they ask, like my rich dad taught me to ask, “How can I afford that?

The rich, instead of cutting expenses, increase them. The key is that they increase a certain type of expense that will later make them richer.

The power of the pay yourself first principle

I want to share two stories that illustrate what I mean.

Here is the first story:

Buy cash flowing assets with income, then pay expenses with cash flow

Here is the second story:

Income from salary pays for expenses.

You may say, “I thought you were going to share a story but those are just pictures.” But as they say, “A picture is worth a thousand words.”

Study the diagrams above and see if you can pick up some of the distinctions between the two stories. If you’re financially intelligent, you can see important distinctions and you can see the story that they share.

The first diagram depicts the actions of those who put the pay yourself first principle into action. Each month they allocate money to their asset column before they pay their monthly expenses.

The second diagram depicts the actions of those who pay everyone else before they pay themselves. Each month they allocate money to their expenses column and then save or invest with whatever is left over—which is usually nothing. This is the diagram of those in the rat race, no matter how much money they make, they are poor.

If you understand the power of cash flow, you will understand what is wrong with the second diagram. It’s the reason why 90 percent of people work hard all their lives and need government support like Social Security when they are no longer able to work. The reason is they pay themselves last.

In order to be rich, you must have the self-discipline to pay yourself first. By this, I simply mean using your income to invest in cash-flowing assets before you pay your bills or buy anything fun. This in turn will create more income that you can use to invest in more, cash-flowing assets. Do that and you’ll have more money than you know what to do with.

Paying yourself first is not easy. In fact, it can be scary, especially when the bills are piling up. But you must develop the self-discipline to do it.

Saving is not paying yourself first

It’s important to note that saving does not equal paying yourself first. I’ve written a lot about why savers are losers. If you simply save money each month, you will never get ahead financially.

Rather, you must save with a purpose. Both Kim and I have some savings set aside in the form of liquid assets like cash, gold, and silver, which we can use in an emergency. But the majority of our money goes into saving for investing into cash-flowing assets. It is these cash-flowing assets that then put money into our pockets each month. And it is cash-flowing assets—i.e., money working for you—that gets you out of the rat race.

When you have passive income coming in each month from your investments, you don’t need a job and you don’t need a salary. You are financially free, and only then are you truly rich.

Original publish date: June 19, 2018

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