How to Live Below Your Means (and Pay Yourself First)

Live below your means and pay yourself first; or in other words: don't spend it all today; save some for your future self.

These are the fundamental principles of personal finance. Following this advice, together with choosing appropriate investment options held in the rights accounts will most certainly see you reach your personal finance goals.  

Unfortunately, many people struggle to live by these guidelines. This is evident by the amount of debt Canadians carry. As of the second quarter of 2022, Equifax reported the average non-mortgage debt per consumer was $21,183. High inflation and rising interest rates are causing even more financial hardship.  

How to Live Below Your Means 

To live below your means refers to not spending every dollar earned today. This allows you to save some of it for future expenses.  Future expenses might include short-term or on-going savings goals like:  

Spending less than you earn also leaves money to allocate to long-term savings goals such as: 

• Retirement 
• Education fund for kids 
• Vacation property 
• Once-in-a-lifetime trip 

The above lists include examples of very common things people either need or want to spend money on. The only way to make that possible without going into debt is to save some of today’s dollars for future goals.  

Easier said than done, I know, but keep reading for suggestions on how to make it happen. 

What is 'Your Means' in Dollars? 

In order to live below your means, first you need to calculate the amounts coming in and out.  Traditionally a budget breaks things down into fixed (the needs) and variable (the wants) expenses. What gets included in each category varies depending on whose budget template you follow. 

Is it a Fixed or Variable Expense?  

We can debate what a fixed and variable expense is, but personally I think it should be less about categorizing spending and more about ensuring the amounts are reasonable for each expense you choose to incur.  

This is especially true when it comes to cost of living expenses like rent or mortgage, mobile or Wi-Fi plans, home or auto insurance, car payments and groceries. While all of these things are typically categorized as fixed, it doesn’t mean you can afford the versions you chose or that you don’t have some control over the 'fixed' expense.

Can You Afford Your Expenses? 

Perhaps the home you purchased or the rent you’re paying is more than you can afford. Maybe the mobile plan you chose is double what you actually need. By shopping around, there's a good chance you could get home and auto insurance for less. Grocery expenses could likely be reduced with meal planning and shopping with a list. (You can insert your eye roll here).  My point: fixed expenses aren't necessarily fixed. While you do need to spend money on these things, the costs are somewhat within your control. 

When it comes to typical variable expenses like clothing, take out or entertainment, while most budgets suggest you cut these first if you're looking for ways to live below your means, I would argue that you keep them if they are important to you. However, just like fixed expenses, you need to consider whether the amount you are spending is these categories is reasonable given your income. 

Save Some Money for Your Future Self 

The exercise in figuring out what you need and want to spend each month shouldn’t just be adding up fixed and variable costs, but taking a look at each item and reducing costs where you can, without sacrificing the things you really enjoy. Finding a good balance is essential. When you do this, you make room in your budget to pay yourself first, which should be a priority for the sake of your future self.  

How to Pay Yourself First 

Pay yourself first suggests that you set aside money from today's budget, to pay your future self. 

Once you’ve optimized your spending (which I recommend doing at least once a year), and know how much of your budget you can allocate to paying yourself first, the next step is to figure out what your short- and long-term goals are. In other words, what are you paying your future self for? 

Determine Your Saving Goals  

Retirement should be at the top of everyone’s list. Yes, even before your children’s education. Think of it the same way as the safety demonstration on an airplane: put your own mask on first, before you help someone else. 

After retirement, your savings goals will depend on your priorities. If you can afford everything on your list, lucky you. For most people, it’s a matter of making compromises either by removing or altering a goal or changing the time frame that they can accomplish it in.

For example: You want to save for your child’s education in a Registered Education Savings Plan (to take advantage of the government grants) and also want to travel with your kids. As a result, you might choose to reduce contributions to the RESP for a few years and allocate funds to saving for an annual vacation instead. 

Once you’ve decided on your savings goals (they should be reviewed annually too), you’re ready for the next step.  

Automatic Payments Will Be the Key to Your Success 

The best way to pay yourself first is to set up automatic payments to your savings and investment accounts.  

Automatic payments are proven to help people reach their short- and long-term financial goals because it takes away barriers to saving such as:  

• Having to track spending to ensure there’s money left to save  
• Remembering to deposit the money to savings 
• Finding the time to deposit the money 

The reasons automatic payments work best to reach financial goals include: 

• The exact amount needed is being saved, not just what is left over. 
• The money is removed from your chequing account so it can’t be spent.  
• Transfer of the money won't be forgotten; it will just happen.  
• Growth is realized faster due to regular contributions and compound growth.

Where to Save Money for the Future 

The other component to paying yourself first is ensuring you’re paying yourself in the right type of account.  

Short-term Goals 

Money for short-term savings is generally best saved in a High Interest Savings Account (HISA) or Guaranteed Investment Certificate (GIC), depending on your timeline. This is because these accounts guarantee the capital and pay interest. 

You can open a HISA or purchase a GIC through most major banks, although I encourage you to consider online banks like EQ Bank, Simplii or Tangerine (there are many others) for these types of accounts, as they often offer higher interest rates. You can easily link online-only bank accounts to your chequing account to make setting up automatic payments easy. 

Long-term Goals 

Money for long-term savings like retirement or a child’s education is best saved in a tax-sheltered account like the RRSP, TFSA or RESP. These types of accounts can be opened through a bank, online investing platform or through an independent financial advisor.  

It is in your best interest to get this right, since choosing the wrong account (RRSP or TFSA?), the wrong type of investments (individual stocks, bonds, mutual funds or ETFs?) or paying high fees, will have a big impact on the future value of your accounts. Doing your own research, speaking to friends and consulting with a financial advisor are all highly advisable.  

How Much Should You Save? 

To determine how much to save for each category, first determine the end goal.  

To calculate the amount to save for a short-term goal like a vacation or a vehicle, divide the amount you expect to spend by the amount of time you have to save for it. 

Example:  If it’s January and you need $10,000 for a vacation that you plan to take in January next year, you have 12 months to save. $10,000 divided by 12 months = $833.33 per month needs to be saved.  

For a bigger goal like retirement, it becomes more difficult as there’s no specific amount to save. The amount you need will depend on your desired lifestyle and retirement age. In this case, use industry guidelines. Saving between 10% to 20% of your gross income is generally recommended. (If you have a pension, you should still be saving over and above, as most plans aren't going to pay enough). 

The sooner you start, the less you need to save. Assuming a retirement age of 65, someone who starts saving at 25 could likely save just 10% of gross income while someone starting at 40 might need to save 20% to 30%+ of gross income to retire with the same amount. 

A financial advisor can project these figures for you based on your personal goals, income and age and help you determine the amount you need to save.  

What’s Next?  

The road won’t always be smooth. Life has a way of throwing us curveballs and flexibility will be essential.  

You might have to postpone a vacation or stop automatic payments to the RRSP temporarily so that you can divert funds to the furnace you weren’t expecting to replace. In contrast, you might be in a position to increase contributions to the RRSP or catch up on RESP contributions if you get a higher paying job, a raise, a bonus or receive an inheritance.  

So, what's next? Get acquainted with your expenses, negotiate them regularly and make conscientious spending choices so that you can live below your means while still enjoying life. Most importantly, be sure to pay your future-self first with the secret sauce: automatic payments.