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Tuesday, 14 October 2008

Pay yourself first: Does it really work?

by Ma. Salve Duplito

MANILA, PHILIPPINES - If financial planners are to be believed, the road to wealth is paved with things like "paying yourself first" -- a clever way of saying automatic savings should be at the top of your priorities. In other words, pay yourself first before you pay the electric, telephone, cable television and other bills.

It sounds deceptively simple. You"ll find financial gurus David Bach (Start Late, Finish Rich), George Clason (who wrote the 1926 classic The Richest Man In Babylon) and Efren Ll. Cruz (Pwede Na: The Pinoy Guide to Personal Finance) preaching that if the government can automate taxes, you can do the same thing with personal savings.

That means you set aside a chunk of your income automatically every month even before you see your paycheck, and put the money in a "no-touch" investment account and leave it there to grow. Then live on what is left of your income, even it means switching to cheaper brands, taking the jeepney, canceling magazine subscriptions or doing extra work.

Some financial professionals go as far as saying this principle is the golden rule of personal finance. Started early, it allows you to earn interest from interest (magic of compounding). It begins the discipline of saving. Forced to live on a smaller income, it makes you conscious of your lifestyle choices. It gives you the satisfaction that giving up certain perks now means your golden age will truly be that: happy and secure.

It is also easier said than done. That money could be used for many other things. It can pay for gas, the grocery bill this month, tuition, or the new computer Junior needs -- all necessities, really. Some of us have tried to do it once or twice before, or an unforeseen emergency caused us to dip into the kitty. That normally becomes the end of the story.

There's also the hard nosed reality Filipinos have to deal with: almost half of the population live below the poverty line and many are in debt.

How in the world can people who live on minimum wage pay themselves first?

Perhaps the more crucial question would be, does this really work in the Philippines where poverty is high, interest on savings are extremely low and loan sharks are more accessible than banks?

"Paying yourself first is for everybody," says Cruz in an interview.

As chairman of Personal Finance Advisors, Cruz has worked with hundreds of individuals and organizations on how to build personal wealth. He once shared how a janitor who worked in Quezon City built a sizeable savings by religiously socking away money and doing other odd jobs. He says that when most people say they don"t have enough income to save, the truth is they are just living beyond their means.

When that"s the case, people spend first and then save what is left of their income. That almost always ends up in zero savings or living in debt. The key is to jump in through forced savings, and live on what's left.

"In preparing for a financial event, the fastest way to accumulate funds is to save, which is paying yourself first. Investment only hastens such accumulation, but everything starts from saving," he says.

The strategy, however, goes beyond just savings. It also means looking at what's left to spend on and adjusting your lifestyle even if it means cutting the cable connection or chucking the mobile phone.

Needs commitment
It needs a lot of commitment. It also requires much creativity. To make it work, all consumer debt should be fully paid.

"It has to start from taking a serious look at how money is spent, then maybe rearranging the family budget to allow for such savings, and even assessing whether the family income is really enough. Paying off debt is part of rearranging the family budget," Cruz says.

Most Filipino families will have to attack both sides of the equation. If expenses can no longer be squeezed, then increase income by doing extra work or starting a small business on the side. That's Cruz' holistic approach to building wealth.

To make the "pay yourself first" strategy work, financial experts say you have to make saving painless. Here are some tips to make this happen:

1. Pay your debts. There"s no use trying to build up wealth if you are paying 42 percent per annum on consumer loans, or even more to the "5-6" operator next door. Just paying off your credit cards frees up P42 out of every P100 in your budget. That"s truly a painless way to save money.

2. Automate savings. Open a separate account and arrange with your bank to transfer funds automatically at a certain day of the month. If you don"t see the money, don"t touch it, saving it becomes painless. If your bank can't do this for you, transfer your money to another one.

3. Transfer the funds to a higher-yielding savings, trust or investment account. Better still if the funds are locked in. You can look, but not touch. Reevaluate every year if returns match your goals, but stay clear of scams that offer returns that are too good to be true. Invest only in vehicles you understand.

4. Pretend you didn't get a bonus or a raise. You"ve lived on your income for a year, how much more difficult would it be to live on the same amount this year? Take out a small amount of fun money (say 5 percent), then add the rest to your investment account.

5. Invest unexpected windfalls. Filipinos are great at planning, especially when it"s about spending some unexpected commissions, gifts, inheritance, earnings from a sideline or other kinds of sudden windfalls. Get out of the habit of spending money you have not yet received. Instead, sock it all away and make it grow. Filipino blogger Digerati Life (http://www.thedigeratilife.com) shared how this technique has helped her make great progress in her savings program.

6. Look for new ways to earn more. Sidelines and "rackets" (make sure they are legal) increase the amount you pay yourself regularly. Ask businessmen friends what needs they have that you can provide. Perhaps you can earn extra by sharing your expertise among your friends. This is the age of knowledge workers -- Swarovski and jewelry makers are not the only ones who can make a living out of their spare time.

This article was first published in The Philippine Daily Inquirer on August 24, 2008.

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