Pay yourself first or last?

Adam (a staff writer at Get Rich Slowly) wants you to “challenge yourself” by replacing the the standard ‘pay yourself first’ advice with:

Only pay yourself first if you deserve it.

Now, Adam isn’t suggesting that you stop saving that 10% to 15% of your gross income that the bulk of the personal finance blogosphere recommends …

… what Adam is really asking is:

Should You Stop Funding Retirement to Focus on Debt?

[This] is one of the most heavily debated dilemmas in personal finance. Unlike “spend less than you earn” or “track every penny you spend”, there’s no cookie-cutter answer to this question. Variables such as age, career, risk tolerance, and even personality type make each individual situation unique.

This is a good line of questioning – and I encourage you to read his article – but, unlike Adam, I think there is a “cookie-cutter answer to this question”:

You should always ‘pay yourself first’

but, where you place that money depends on where you earn the greatest after-tax return.

Keeping in mind that a “dollar saved is a dollar earned”, it could be in:

– Your 401k, potentially earning 8% plus the value of any employer matches (in an earlier post, we calculated this as providing another % point or two to your long term return),

– Your debts, potentially saving 10% to 30% interest on high-interest car, credit card, and consumer loans,

– Your real-estate investment strategy, potentially earning 15% to 25% in long-term rental increases and capital appreciation,

– Your seed capital for your new business, potentially earning 50%+ in future profits and windfall gains on the sale of the business,

– etc.

But, is unlikely to be found in paying off low interest student loans (saving 0% to 5%) or mortgages (saving 4% to 6%) or in investing in low interest savings such as bank accounts, bonds, or CD’s (earning 1% – 5%).

Blindly plonking your money into your 401k, or paying off debt, or paying down your mortgage is not the way to get rich(er) quick(er) … 7m7y readers always look at their options in terms of greatest contribution to reaching their Number.

Be Sociable, Share!

12 thoughts on “Pay yourself first or last?

  1. Adrian,

    I agree: A dollar saved is a dollar earned.

    However, in terms of prioritizing investment vs. pay-off opportunities, I am opting the route of paying off debt 1st. By end of 2010 I will have paid off all of debt except for my primary mortgage.

    That will reduce my monthly expenses and together with a healthy cash balance of at least a year of expenses will put me in a position to quit my corporate job and allow me to renew my entrepreneurial quest.

  2. Although your math is correct, and I understand the logic, I prefer to be debt free. I think it’s more of a psychological preference.

  3. @Jake. I too am opting for pay down debt. In fact, I think you and I had the same goal! I actually successfully “zeroed” a few days back. Now I’m taking the advice of the four hour work week, but I’m only on chapter three or something, and it’s telling me to take the first steps of my dreamlined “lifestyle” management. Needless to say I’ve already ramped by credit card debt up with a planned ski trip and a kitchen backsplash. Whatever. A guy’s gotta live, that’s what we’re here for. Nothing wrong with celebrating paying off debts, is there (should “zero” again in a couple of pay checks). Take it easy.
    @AJ — ok, so maybe, let’s say, someone I know has tons of low interest student debt, I guess what should happen is some of that debt is paid off and some is diverted to the growth engine start-up costs — or all to start-up costs? I guess there is no cookie cutter answer for this question?

  4. Adrian,
    You keep bringing up the 401K retirement plan in many of your posts. I would like to give my opinion on these, and would love to hear others opinions as well.

    Personally, to me , 401K’s are not a great place to invest/save money. First off, most companies(employers) have no clue as to what these plans offer,yet will blindly offer them to their employees. Second,most companies don’t even know how much the fees are. Many companies choose these retirement plans based on facts like, they are offered free checking or some other incentive,through the provider.
    Next, its these fees,that so many of the providers charge. They can be enormous,in many cases taking as much as 70% of your returns over a period of 20 or 30 years.Then again,these investors (on your behalf) might not know any more about investing than you or I.So,its possible you could receive a better return investing your own money. then again, what happens if this company goes bankrupt? will you get your money back? or only a small fraction of it?401 K’s in My opinion are a dangerous gamble with your hard earned cash. Look how many people near retirement age find they have little to show for their efforts to save ,and will be required to work longer than expected.

  5. @ Josh – like CareerAde, you may be the ‘exception that proves the rule’: by being debt free (and, you may still be living with your folks, too?) you have total freedom to risk as much of your capital / net worth as you like on business ventures, yours being trading the market in penny pharma stocks.

    On the other hand, if you delayed starting your venture/s in order to first pay off debt, then you should be asking yourself why you are paying down 5% (say) debt and delaying (potentially) 50%+ income?

    @ Ill Liquidity – see above? 🙂

    @ Steve – Agree!

  6. thats an excellent question to ask oneself…
    Its difficult to remember being in debt, it was about two years ago, but what I actually did was take a two sided action.
    1. I aggressively liquidated the toys (expensive car) and downgraded to pay off debt and…
    2. aggressively began saving money through my employers 401(k) plan as well as a personal brokerage account.

    this may not sound like the optimal strategy, but I think it was the best move for what I had to work with, which was no knowledge of investing, and little chance of consistently making greater then the 6.5% that I was paying my debt.
    I guess it comes down to how confident you are that you can make more then your debt interest.

  7. Definitely, but when I trade with margin, it effects my emotions. I know it’s possible to lose more then I have and it shakes my nerves, causing me to trade poorly. I figure making 50%+ and I wont need margin.
    Also, I’m scrapping the whole hedge fund idea. It will take about 50 million to cover the expenses of the fund if I charge 1% of invested capital for fund expenses, assuming it will cost at least 500K per year to run the fund. the problem is nobody is gonna hand over 10 million, never mind 50 million to someone with my background and experience.
    So I figured I would just trade my own portfolio, which has been coming along well. I honestly wouldn’t be surprised if I exceeded my number by this time next year.

  8. Steve,

    You have a good point about fees- although it will vary from plan to plan- if you change jobs you should transfer the balance from the 401K to an IRA. With an IRA you can get very low costs and more investment choices. Now if they would just let me transfer the balance without changing employers!

    Unless you are investing in your company’s stock in your 401K the money would be safe if the company folded- here is an article that talks about that:


  9. @ Steve – if your 401k is fee-laden, agree. if your 401k is very low fee with a great provider with Vanguard like mine (and your employer actually spends $ to buy down your fees), I disagree. In that case the 401k is a great piece of the puzzle. BTW, I sincerely doubt that you would lose your investment if either the employer offering the 401k or the plan administrator (e.g. Vanguard) went belly up. You *own* the assets in your 401k (as long as you are vested), no one else.


  10. That “pay yourself first” concept sounds really familiar. I think I remember reading it in the book “The Richest Man in Babylon”. Is that where it originated or has that been around even longer?

Leave a Reply