Do This When You Get Paid (Paycheck Routine)

It's Friday, and you've got your paycheck. 

You might think about buying new shoes, going to a fancy restaurant, or catching a movie. 

But before you know it, your money is all spent. 

When you receive your paycheck, it can be tricky to figure out the right things to do with it. 

So today, I'm going to guide you through eight important steps you should take with your money as soon as you get paid.

Step #1

Let's start with the first step. 

This is the most crucial thing to do, which is to establish your financial baseline. 

Many people feel it's too much work, but that's why most people struggle. 

64% of Americans live paycheck to paycheck because they make one of the most significant financial mistakes, which psychologists call "mental accounting." 

Essentially, it's when you mentally categorize your money instead of writing it down.

For instance, let's say you get a tax refund from the IRS in May. 

You might mentally label this as extra spending money and get excited, perhaps spending it on a new PS5 or a new TV. 

The problem is, this money is no different from your regular income; you've just paid too much in taxes, and the IRS is returning it to you. 

How Do You Solve This?

The good news is, the solution is simple: 

open up a spreadsheet and list all your monthly expenses, including things like rent, internet, and food.

Creating this Google sheet is an excellent way to figure out how much money you need to cover your basic needs each month while maintaining your current lifestyle.

If your income varies, like in my case as a self-employed individual, this becomes a valuable number to know.

Now, the real work begins.

Remove the expense items that aren't your absolute essentials.

That means Netflix, staplers, and your Candy Crush subscription are off the list.

Instead, you want to focus on core expenses like housing (that’s your rent or mortgage), which should be around 30% of your income, groceries (about 10% of your income), and insurance and utilities (like internet, cell phone, and electricity, also about 10%).

This final number is your financial baseline, the absolute minimum you need to survive each month.

Your goal is to keep this baseline under 50% of your total income.

If it goes over, look for expenses you can swap for cheaper alternatives.

For example, reconsider that apartment with an indoor pool, a phone plan with satellite coverage, or those fancy organic avocados.

Step #2

Once you've established your financial baseline, it becomes the bedrock for the next step. 

Think about how it would feel to have saved up an amount equal to six months' worth of your expenses in your bank account at all times. 

Imagine the kind of freedom and peace of mind you'd enjoy, knowing that if you ever fell ill, lost your job, or had an accident, you'd be perfectly fine. 

This is why having an emergency fund is so vital.

Mathematicians describe it with Murphy's Law, which basically means that if something can go wrong, it will go wrong. 

Instead of having to ask your parents for money again or racking up credit card debt or even taking out a loan, your emergency fund would be your safety net. 

Here's the stark reality: studies have shown that as many as 56% of Americans can't afford an unexpected expense of $1,000 dollars, and a shocking 22% have no emergency fund at all.

My Past Experience

I remember a time when I had a car accident at the age of 20, and it cost me about $5,000 dollars to repair it. 

Now, if I hadn't saved up an emergency fund, I might have had to take out a loan. 

Paying back that loan with interest could have easily cost me more than $7,000 dollars.

Generally, your goal is for your emergency fund to cover the equivalent of six months of your financial baseline. 

So, if your baseline is, let's say, $3,000 dollars a month, you should aim to save up $18,000 dollars for emergencies. 

But remember, emergencies don't include funding wild nights out, vacations, or satisfying your pepperoni pizza cravings (sorry that’s just me). 

This money should be reserved for when everything seems to be falling apart - like when your house is flooded, or you're stranded in the middle of nowhere with no other options. 

Essentially, you use your emergency fund when your life is in complete disarray. 

So, make building up your emergency fund a priority.

Step #3

Once you are done with that, move on to the next step. 

Surprisingly, 77% of American adults are in debt, and this is something we've all come to accept as normal. 

Maybe we splurged on luxury clothes we didn't really need to maintain a lifestyle we couldn't afford or bought new furniture when we could have found great deals on Craigslist.

Debt is particularly troublesome because it squeezes your monthly income. 

When you're shelling out hundreds of dollars or more for credit card bills, car loans, and other debts, it quickly gobbles up the amount you could be saving and investing. 

So, never mind cutting back on avocado toast and iced coffee; the real money-saving game-changer is paying off your high-interest debt, which can save you thousands in interest and fees.

Why Is This So Important?

Let me illustrate why this is so important: 

Suppose you have a credit card balance of $6,500 dollars with an interest rate of 19.5%, and you decide to make only the minimum amount of $130 dollars per month. 

Guess how long it will take you to pay it off? 

It will take a whopping 8 years to pay it all off, with an additional $6,000 dollars in interest you have to pay on top of that. 

So your total paid is $12,500 dollars on $6,500 dollars worth of credit card charges. 

So, what's the best strategy to rid yourself of high-interest debt early?

Well, there’s two main approaches.

i) Debt Avalanche Method

The first one is the Avalanche method. 

Here, you target the loans with the highest interest rates first – those pesky credit cards, payday loans, car loans, or any loans with an interest rate of 10% or more. 

You pay off the one with the highest interest rate and then move on to the next, and the next, and the next. 

Mathematically, this is the cheapest and most efficient way to clear your loans.

ii) Debt Snowball Method

The second option is called the Snowball method, this one takes a more psychological approach. 

Instead of focusing on the interest rates, you tackle the smallest loan amount first. 

These smaller debts can be paid off relatively quickly, which builds momentum and motivates you to keep going.

For me, when I got serious about managing my personal finances and paying off my debts, I consolidated all the details into a Google spreadsheet. 

This sheet included each debt, the amount I owed, and their interest rates. 

Every time I made a payment, I would open the spreadsheet and manually adjust the remaining amount. 

Every other day, I would visualize paying off the debt completely until the balance hit zero. 

This kept me motivated and helped me stay on track.

Once you've managed to pay off your high-interest debts, you'll find that you have a bit more financial breathing room every month.

Step #4

But before taking any action, it's crucial to prioritize the next step in your financial journey. 

When many people think about investing, they imagine flashy screens, day trading, and all sorts of aggressive financial acrobatics. 

But, contrary to what you might have seen in movies like "The Wolf of Wall Street," investing doesn't have to be this intimidating or overwhelming thing. 

In fact, the basics are straightforward, and once you get the hang of them, you can set yourself on the path to accumulating substantial wealth over your lifetime.

Albert Einstein On Compound Interest

Albert Einstein once remarked that compound interest is like the eighth wonder of the world. 

He who understands it earns it; he who doesn't, pays it.

Compound interest is the secret sauce that makes it imperative to start investing as soon as possible. 

Over time, the stock market typically returns around 10% per year. 

This means your money essentially doubles every ten years without you needing to lift a finger. 

Let me give you an example: If you invest $6,000 each year from the age of 25 to 65, with an annual return of 10%, you'll end up with a grand total of over $2.7 million dollars.

However, if you decide not to invest and instead stash your money under your mattress, you'll be left with just $240,000 dollars. 

That's an enormous difference and could potentially transform your life.

What Investment Account Should You Start With?

Now, the question is, which kind of investment account should you start with? 

Should you open a taxable brokerage, a 401(k), an IRA, or an HSA? 

Figuring out the order to prioritize these accounts will help maximize your returns while minimizing your tax burden.

For most people, it's a smart move to begin putting your money into a 401(k) account, especially if it's a workplace retirement plan that offers matching contributions. 

Essentially, this matching contribution is like free money! 

If your 401(k) plan offers this match, you should contribute enough to meet those matching amounts. 

When it comes to your 401(k), you're not only grabbing some free cash, but you're also reducing your taxable income.

For example, if you're earning $90,000 per year, and your employer matches up to 3% of your salary, they're giving you $2,700 dollars of free money if you contribute 10% of your $90,000 income to your 401(k) plan. 

And when tax season rolls around, you'll only be taxed on $80,000 instead of your full $90,000 dollar salary.

Step #5

Once you've taken full advantage of your employer's matching contributions in your 401(k), the next smart step is to contribute to a Roth IRA account. 

Unlike the 401(k), where contributions are made with pre-tax dollars, a Roth IRA works a bit differently. 

With a Roth IRA, you'll use post-tax dollars. 

This means you pay taxes on your full $90,000 dollar salary before you can contribute to your Roth IRA.

The beauty of a Roth IRA is that you won't have to pay taxes on any of the earnings that accumulate in this account, and you have the flexibility to withdraw your contributions at any time. 

So, while you're stashing money in a retirement account, you're also allowed to take money out from the initial contributions whenever you need it.

Step #6

Once you've made the most of your retirement accounts, it's time to consider investing in a standard taxable brokerage. 

Unlike 401(k)s and Roth IRAs, these regular brokerage accounts don't offer any immediate tax advantages. 

However, they're still one of the best places to park your extra money.

In all my investment accounts, I tend to focus on low-cost ETFs, which are suited for long-term investing.

What Does Long-Term Investing Means To You?

Now, when we talk about long-term investing, we mean you're not monitoring your account daily, weekly, or even monthly. 

You're more the "set it and forget it" type. 

You check in maybe twice a year, ensuring everything's in order, but you're not stressing every time the stock market takes a dip.

One of the significant issues here is that many people can't handle the market's ups and downs, especially when things look a bit shaky. 

This is when a common financial mistake occurs, known as "timing the market." 

It involves reacting to market performance by either stopping investments or pulling your money out to wait for what seems like the right time to jump back in.

2 Issues With Timing The Market

There are two key issues with this approach. 

Firstly, no one can predict whether the market will go up or down because it's highly unpredictable. 

It's almost like economists making countless predictions, but only a few of them ever come true.

Secondly, even if you manage to pull out when the market is performing exceptionally well and avoid a crash, you'd need to be right a second time to reinvest your money when it's ideal. 

This is close to impossible.

The better way, based on mathematical data, is to invest a fixed amount every month consistently, regardless of market fluctuations. 

This approach is often referred to as Dollar-Cost Averaging (DCA).

When you stick to a regular investment pattern, you'll end up with more shares when prices are low and fewer when they're high. 

Over time, this strategy reduces the average price you pay per share.

Case Study Using DCA

Imagine you have $300 dollars to invest in a volatile stock called Vanilla Investor Company. 

In the first month, the share price is $10 dollars, in the second month it's $5 dollars, and in the third month, it's $20 dollars. 

If you decide to invest $100 dollars each month for three months, here's how it works:

• In the first month, you buy 10 shares.
• In the second month, you acquire 20 shares.
• In the third month, you only get 5 shares.

In total, you now have 35 shares that cost you $300 dollars. 

This results in an average share price of $8.57. 

While this isn't the lowest you could’ve acquired the shares (that was at $5 dollars, if you magically predicted the future), it also isn’t the highest, which was $20 dollars (if you’d invested all your money during the peak). 

It's more a balanced approach to investing.

Step #7

After you've made your investments, let's move on to the next step, which involves recognizing that in life, time is the most precious resource. 

It's the one thing we can't purchase more of. 

No matter how much money you have saved or earned, if you don't have the time to enjoy your life, it doesn't really hold much value. 

In the realm of economics, this is often referred to as "opportunity cost." 

Essentially, it means that the time you dedicate to one activity is time you can't use for something else.

An Example

For instance, consider your Sunday. 

You might spend three hours cleaning, washing floors, wiping windows, and taking out the trash. 

But what if you used those three hours to work on a side hustle where you could make $80 dollars? 

If you could hire someone to clean your house for $20 dollars, then perhaps your time is better invested in your side hustle. 

Over time, the difference you earn can be used to invest, grow your finances, and buy back even more time to do the things you love.

Should You D.I.Y. Or Outsource?

To decide if it's financially more sensible to hire someone or do a task yourself, here's what you can do:

1. List the tasks you absolutely dislike doing, such as cleaning the toilet, mowing the lawn, or driving 45 minutes to get groceries.
2. Estimate how much time each task consumes.
3. Consider how much money you could make during that time if, instead of doing these tasks, you were working on your side hustle.
4. Check how much it would cost to hire someone else to handle these tasks for you.

By putting all this information together, you can make a more informed decision about whether it's better for your finances to hire someone to do certain tasks or to continue handling them yourself.

Step #8

But the most crucial step in all of this is automation. 

I remember for a long time, I did everything manually – paying bills, saving for a house, and investing. 

The issue with this manual approach is that it consumes dedicated time and mental energy every single week. 

In the field of psychology, they refer to this as "decision fatigue." 

Essentially, when you make numerous decisions throughout your day, the quality of each decision tends to decline over time. 

In the morning, you might be able to make excellent choices one after another, but as you get closer to making 10,000 decisions, you could end up making mistakes that you later regret. 

Maybe you buy something like a pair of AirPods Max or even an overpriced stapler.

What Should You Do Instead?

But what if I told you there's a way to easily automate your finances so you never have to worry about that again? 

Setting up financial automation will save you a tremendous amount of time and spare you from headaches in the long run. 

Nowadays, I don't even have to think twice about whether I've paid my bills or if I've invested this week because I know it's all taken care of. 

Here's how to do it:

1. Ensure your paychecks are directly deposited into your checking account.
2. With your bank, establish automatic transfers to allocate your paycheck into two new accounts: your spending account and your savings account.
3. Your spending account should cover your fixed monthly bills and essential expenses like groceries, gas, and, yes, even pepperoni pizza. Determine your typical monthly expenses and set spending limits for non-essentials, like dining out, going to the movies, or shopping.
4. Arrange automatic transfers at the end of each month to move any surplus funds into your savings account, which is dedicated only to savings.

From there, the money in your savings account should flow into the specific steps you're working on, whether it's building an emergency fund, paying off high-interest debt, investing, or addressing opportunity costs. 

Now, if you enjoyed the article and find it useful, be sure to share it with family and friends!

Cheers and stay invested!

- Ivan