If you’re like me and you get your pay monthly, the anxious feeling of being down to your last $50 a week out from pay-day is all too familiar. For too long I’d failed to plan my spending, saving, and investing allocations properly, which resulted in me living the social life of a hermit the weekend before being paid. Or even worse, withdrawing from my home deposit savings account.
We all know how great it is when we get paid. You get this temporary euphoric feeling of having more cash than you know what to do with, especially if you’re paid in monthly lump sums like me. Unfortunately, I was in the terrible habit of spending my hard-earned pay all too quickly.
What I didn’t realise was that being paid once a month can actually make budgeting much easier, rather than difficult. When you’re paid monthly, you can automate your cash-flow a lot easier to ensure you’re not scraping for your last few bucks when it comes to the end of the month. Like anything worth doing, it just takes some time and discipline. It took me way too long to realise this, but better late than never!
Keep reading to discover some must-dos when you get your next paycheck!
1. Know Your Expenses & Pay Them All At Once.
Think of your paycheck like a pizza. Like a pizza, your paycheck needs to be divided into different slices. And one of those slices is your monthly expenses. Knowing the total dollar value of your monthly expenses is paramount to a successful budgeting strategy. Take 15 minutes to go through your bank statements and understand what you’re paying for each month. From rent, insurances, and credit card repayments all the way to your Netflix subscription, you want to know exactly what your monthly outgoings are. This is also a good opportunity to cull any un-wanted or unnecessary subscriptions you have no use for.
If you have some annual expenses, it’s worth calculating what they’d cost you if you had to pay them monthly. Once you know that number, set it aside each month as if you’re actually paying it. That way you’re not hit with the shock of paying a large lump-sum amount at once.
Now that you’re aware of your monthly outgoings, set-up an automated bank transfer to pay each of your bills the day after you’re paid so that all your bills are paid for at once. Most banks should offer this service, which can be done through their respective online banking platforms.
So, what if your expenses are due at different times throughout the month? Most companies are willing to work with you to change the due date, especially if you are setting up an automated payment or direct debit. Simply call and ask to get your monthly due date changed.
2. Start Building An Emergency Fund
The power of an emergency fund is invaluable when used appropriately. When you’re in your 20s, living paycheck to paycheck is likely something you’ll experience at some point. But living on the edge is only tolerable for so long. The power of having some money put away for a rainy day gives you a mental sense of security should you suffer an unforeseen expense or loss of income. A good number to strive for is 3-6 months’ worth of expenses.
How Much To Contribute?
It’s important to start building up your emergency fund as soon as possible. I personally contributed 5% of my paycheck every month to my emergency fund, which meant it took me just over a year to get the balance up to roughly 6 months of expenses. How much you contribute to your fund is entirely dependent on what you can afford to spare per month. What’s important is that you go ahead and make the conscious decision to start adding to an emergency fund.
Remember that an emergency fund should be used for emergencies only. So, unfortunately, that new bike you’ve been eying off doesn’t meet the criteria. To keep your funds safe from losses and easily accessible in times of true need, your emergency fund must only be invested in a high-interest yielding savings account.
3. Contribute Some Of Your Pay To An Investment Account “Wealth Creation”
Now that we’ve dealt with expenses and emergency accounts, its time to discuss allocating a slice(s) of your paycheck to creating an investment portfolio so you can reap the rewards of compounding. Einstein once said that “compound interest is the 8th wonder of the world” and I couldn’t agree more. If you aren’t so familiar with the compounding effect, let me explain from a numerical perspective.
An initial $10,000 investment compounded annually over 50 years at a 10% interest rate (average return of the S&P 500 since inception) would return $1,173,909.00. And if you wanted to contribute more than your initial $10,000? A $10,000 initial investment + $5,000 invested every year for 50 years at a 10% interest rate would leave you with just under 7 million! Don’t believe me? Then try it for yourself. There are loads of compound interest calculators out there, all with their own nuances for you to do the same calculation. For this example, I used the Money Smart compound interest calculator. You could also use our calculator, which you’ll find below this article.
Essentially compound interest works by accumulating interest on the interest you’ve already earnt, which is why Einstein found the concept so astounding. It’s also why small amounts of capital can grow exponentially with enough time and most importantly, patience.
Where to find the best-Compounded Rate of Return?
So where can you find a solid and consistent rate of return? To reap the benefits of compounding, investing in equities (stocks) is widely known as the only reliable asset class that has produced consistent results over time at a low barrier to entry. If you want to know more about getting started in the stock market, check out our guide.
How Much To Contribute?
How much of your pay-check pizza you contribute to your investment portfolio is entirely down to what you can afford. This is also another advantage of equities (stocks); the barrier to entry is very low. The minimum investment through most online brokers is $500 with others offering no minimum investment. There also micro-investing apps like Raiz and Spaceship that invest automatically for you!
With that said, simply knowing that you should invest in equities is by no means a green light to invest in the first stock you see. Like anything worth doing, investing in stocks will require some time, effort, and patience to refine your skills. So with that said, get researching! (this website is a great place to start, especially this part)
How Compound Interest Can Work Against You
Having lots of high-interest debt is also something to consider before you start investing. By not paying down bad debts like personal loans and credit cards, you’re allowing compound interest to work against you. If you have these debts, it’s worth understanding the interest rates you need to pay and reducing the highest interest debt as much as possible before investing.
4. Contribute To A Home Deposit Account
It’s no secret that Australians have an infatuation with property. It’s always been the ‘Australian Dream’ to own your piece of real estate. So with that in mind, how many slices of your paycheck pizza should you contribute to a home deposit if?
What you contribute is entirely dependent on your personal goals. For example, if you want to place a deposit down on a home within the next 12-24 months, you might consider contributing less to your wealth creation account and increasing your home deposit savings rate. This is why it’s pivotal to ensure you align your spending and saving with your financial goals.
House prices in Australia, the coastal capitals, in particular, have skyrocketed since the recovery from the Global Financial Crisis, making it more difficult for Aussies to come up with a 20% deposit for a property. This is why it’s critical to determine early on if owning a home is something you want to achieve. That way you’ll allow yourself enough time to build up the cash war chest a deposit is going to require.
Similarly to your emergency fund, the cash in your home deposit account should be saved in a high-interest savings account. This will nullify your risk of losses, whilst also allowing you to earn interest on the money you’ve deposited, albeit a low rate. Finder.com does a fantastic comparison of different saving products you can choose from.
5. Don’t Forget To Use You Pay For Living Live
So far our paycheck pizza is doing a whole lot to help you develop strong financial habits, but it doesn’t really allow much money for living life in the here and now. That’s why the final slice of your paycheck pizza is for discretionary spending, which is expenditures you can do without. This cash is to be spent on things and experiences that make you feel awesome, like clothes, your social life, traveling, or whatever else floats your boat.
But how much should you allow?
Start by establishing what you’ve spent in the last 3 months on discretionary expenditure and find the average. Once you have an average figure, you’ve got a basis for what your discretionary spending habits look like.
This is again, another opportunity to trim the fat and make sure you’re not over-committing yourself. If you find that over 40% of your income is tied up in lunches, brunches, and espresso martini’s, it might be worth tightening the belt. I personally aim to limit my discretionary spending to 20% of my monthly income and leave the rest for points 1-4 above. But of course, that doesn’t mean you won’t bump into me at a bar (pre-lockdown) with friends. It just means I know what I can spend and try not to exceed that amount to ensure I’m not compromising my money goals.
With that said, life does get expensive and there will be months where you’ll go above your discretionary spending budget. What’s important is that you have a handle on your spending by creating a monthly spending target that you’re actively working towards.
P.S. I’d love to meet you on Twitter: here.
Want to see more articles like this? You can sign up for our newsletter to get free content first by e-mail!
Disclaimer: This website (the “The Money Pal”) is published and provided for informational and entertainment purposes only. The information in the Blog constitutes the Content Creator’s own opinions and it should not be regarded as financial advice.