Free Money Finance

Save First, Pay Taxes Later

An article that talks about paying yourself first? And also talks about lowering taxes? I'm all over it! Plus, it's written by David Bach, author of The Automatic Millionaire, one of my recommended personal finance books.  Here's a summary of his "pay yourself first" thoughts:

Most people pay everyone else first -- taxman, landlord, credit-card company, and so on. They try and budget every week, month, and year hoping that if they're careful they'll have some money left over. This is absolutely, positively backwards. And because of it over 70 percent of Americans continue to live paycheck to paycheck regardless of increasing incomes. We make more. We spend more. And at the end of the day we're still broke. Are you tired of this game?

"Pay yourself first" means just what it says: When you earn a dollar, the first person you pay is you. Sounds simple, but most people don't do it.

Most people think they have to pay taxes first. Is this correct? Nope. Here's his thought:

You have a right to legally avoid federal and state taxes on the money you earn. You can legally pay yourself first by simply using a retirement account. There are many different types, including 401(k) and 403(b) plans, IRAs and SEP IRAs. The one thing that makes all of these "pay yourself first" accounts is that the money you put in them is either pre-tax or tax deductible.

And using these investment vehicles, you can pile you a significant net worth:

Your goal should be to save one hour a day of your income.

Let's assume you make $50,000 a year. That's about $2,000 every two weeks. If you invested $200 every two weeks for 35 years in a retirement account that earned an annual return of 10 percent what would you have? Quite a pot of gold: $1,678,293.78.

Here's the bottom line:

The point is you can make a lot by setting up a retirement account that pays you before Uncle Sam takes his cut.

Simply great advice all the way around. It's stuff like this that makes The Automatic Millionaire so valuable -- an investment with an almost infinite return.

"Pay yourself first" is also one of the key messages in another of my favorite personal finance books, The Richest Man in Babylon. It's a cheap, quick read that will really help you grow your net worth. If you don't have a copy, get one today, read it, study it, apply it and you'll be on your way to a better bottom line.

Meet the Automatic Millionaires

Here's a piece from Yahoo written by David Bach, the author of The Automatic Millionaire who writes about the time when he met his first automatic millionaire. He starts by detailing how wealthy this couple was despite the fact that they had never earned more than $40,000 a year:

Their combined earnings for the previous year were $53,946. They had no outstanding debts. They owned two homes. The one they lived in was valued at $450,000. A rental property, which was providing them with $26,000 in rent annually, was worth $350,000. Jim's 401(k) balance was $610,000. Sue had two retirement accounts with $72,000. They had $62,500 in the bank, $160,000 in municipal bonds, plus personal property -- three cars and a boat, all paid for. And, Jim's job would provide him with a small pension. Their net worth was approaching $2 million!

Then he compares their results to his:

How could they have possibly amassed such wealth at such a relatively young age? I was confused and embarrassed. Here I was a financial advisor and I was often struggling myself. Yet here were the McIntyres, who probably in their best year made half what I was making, and they were millionaires while I was falling further and further into debt.

Finally, he shares their four secrets with us:

1. Looks Can Be Deceiving -- You don't have to look rich to be rich. There was nothing fancy about the McIntyres. Jim wore an 18-year-old Timex and they were happy to drive their Ford Taurus.

The same day they came to my office, I had a man come in who was driving a new Porsche, wearing a gold Rolex, living in a million dollar home with an $800,000 mortgage. He had less than $100,000 in savings and $75,000 in credit card debt. On the outside he looked rich and successful, but he was far from it.

The McIntyres weren't trying to impress anybody. They focused on putting their money to work for them, rather than having it on display.

2. Set Priorities -- Early in their marriage their parents told them they had a choice: Work all their lives and live paycheck to paycheck like most people or learn to make their money work for them and really enjoy their lives.

How would they do that? Simple. Every time they earned a dollar, they would pay themselves first. Before any bill was paid, they socked away money for retirement, their home, investing, and more.

3. Sweat the Small Stuff -- The McIntyres saw their friends splurge on decorating their apartments and eating out every day, but they didn't follow the crowd. They watched spending, even on the "small stuff."

They both stopped smoking a pack of cigarettes a day and the money saved helped fund their house down payment. They called it the "Cigarette Factor." Today, I call it the "Latte Factor."

4. Cash Only -- Their parents taught them never to buy on credit -- no matter how big the purchase. The one exception: A home. Even then the McIntyres paid their mortgage every two weeks instead of monthly. In addition, they would regularly throw in extra money and wound up paying off their home in their 30s. With the freed up money they bought another house, following the same pay early system. If they did use a credit card, they paid the balance off the same month.

The McIntyres claim no special willpower or super discipline. But what they did have was the smarts to take temptation out of the picture. They arranged to have a portion of their pay automatically taken out of their paychecks. They created a literally foolproof, automatic system to achieve wealth.

Money was taken out of Jim's paycheck and invested in his retirement account. They handled their accelerated mortgage payments in a similar fashion. They used a systematic deduction to automatically invest a portion of both their incomes in mutual funds. They even automated their tithing. What they didn't see, they didn't miss.

Then he comes to the conclusion I've said here time and time again:

If you think you need big bucks to do this, think again! The McIntyres started with amounts as low as $50 a pay period.

And he ends with a recommendation:

Take your first step today. Find out about direct deposit options at your company or with your bank. Then decide how much money you can set aside. Remember you can start small, even $50-$100. Choose a high interest savings or money market account and, if you can, an IRA or mutual fund. Have money automatically directed there monthly. Amassing wealth slowly and steadily can become your story, too.

My thoughts:

1. As I said, I've talked about the fact that you don't need a large income to become wealthy, you just need to spend less than you make. I've said it again, again, and again.

2. People who aren't worried about what others think can amass a great amount of wealth.

3. Just like the other millionaires, these people watch their spending closely.

4. This simple, practical, and effective advice is one reason I recommend the book The Automatic Millionaire. If you haven't read it, you should.

5. I'm currently recommending Emigrant Direct as the place to use as a savings/emergency fund account since it boasts the highest interest rate in the country.