How to Budget Every Paycheck to Build Wealth

TL;DR

Split each paycheck the moment you are paid: keep needs like rent and bills under 25% of income, cap wants near 25%, send 20% to a high interest savings account for a three to six month emergency fund, then throw 30% at high interest debt using the avalanche method. Living on this routine, not earning more, builds wealth.

Transcript

If you spend $5 on a morning coffee on your way to work, $15 on a nice lunch from the food truck, $4 on overpriced transport, $2 on a sweet treat, and $1.40 on unwanted subscriptions every day, then that's the same as spending $10,000 every single year. This is the reality for most people. As soon as they get paid, the money just seems to disappear... Read More

Key Insights

• Small daily purchases quietly destroy wealth: $5 coffee, $15 lunch, $4 transport, $2 treat, and $1.40 in subscriptions each day add up to roughly $10,000 spent every single year.
• The financial baseline is the bare minimum needed to survive each month, covering only needs like rent, insurance, bills, and utilities. The rule: if you can survive without it, it is not a need.
• Needs should ideally cost under 25% of total income. Many sources say under 50%, but keeping the baseline near 25% leaves far more room to save, invest, and build wealth.
• Earning potential is always higher than saving potential, so if bills cannot be cut, increasing income through a promotion or side hustle is the more powerful lever than further cutting back.
• A high interest savings account should receive 20% of each paycheck and act only as an emergency safety net, kept at a separate bank so it is not tempting to spend, not as a tool to make money.
• An emergency fund should hold three to five months of the baseline figure, ideally stretched to six months, so a lost job or broken car can be covered without taking out a high interest loan.
• Paying down high interest debt is the only guaranteed return on investment, since clearing a 20% or 25% debt beats an uncertain 8 to 10% stock return, so 30% of the paycheck should target it.
• The avalanche method pays the highest interest debt first and is cheaper than the psychological snowball method, which pays smallest debts first and cost about $1,700 versus roughly $613 in the example.

Questions & Answers

Q: How much do small daily purchases really cost per year?

Small daily purchases add up dramatically. Spending $5 on a morning coffee, $15 on a food truck lunch, $4 on overpriced transport, $2 on a sweet treat, and $1.40 on unwanted subscriptions every day totals the same as spending $10,000 every single year. These little pleasures seem small and insignificant, but over the long term they rob you of your financial freedom, which is why the creator urges reviewing bank statements to uncover them.

Q: What is a financial baseline and how do I calculate it?

Your financial baseline is the bare minimum you need to get by each month. It covers only needs such as rent, insurance, bills, and utilities. To calculate it, list every essential monthly cost and add them up, for example rent, insurance, bills, and utilities reaching $1,200 a month. The test is simple: if you can survive without something, it is not a need. Subtract the baseline from your monthly income to see what is left over.

Q: What percentage of income should go to needs versus wants?

Many people say your financial baseline should be under 50% of your total income, but the creator argues it should be closer to 25%. Wants, meaning fun stuff like nights out, restaurants, bowling, and golf, should ideally also stay below 25% of your paycheck. Keeping both needs and wants near 25% each leaves roughly 50% of the paycheck free to build wealth through savings, debt payoff, and investing in the later steps.

Q: How much should I put in a high interest savings account?

The creator recommends sending 20% of your paycheck into a high interest savings account. It should be at a different bank from your everyday account, otherwise it is too tempting to spend. This account acts as a safety net you can withdraw from in an emergency, not a tool to make money, so avoid locking the money away for a set time. The creator's own account earned around 4% a year versus about 0.05% on a current account.

Q: How large should my emergency fund be?

Your emergency fund should cover three to five months of your baseline figure, and even better if you can stretch it to six months. Save 20% of each paycheck until you hit this amount. The fund exists for serious situations like getting sick and being unable to work or a car breaking down, not for dipping into when running low. As of May 2023, one in five Americans had no emergency fund at all, leaving them to rely on high interest loans.

Q: Why is paying off high interest debt considered a guaranteed return?

Paying down high interest debt is described as the only place you get a guaranteed return on investment. While stock investing might return a possible 8 to 10%, clearing debt charging 20% or 25% interest delivers a guaranteed 25% return by removing money that eats into your wealth daily. The creator compares high interest debt to a parasite draining your nutrients, arguing you should remove it first, and recommends putting the remaining 30% of your paycheck toward it.

Q: What is the difference between the avalanche and snowball debt methods?

The avalanche method is the logical approach, paying off the debt with the highest interest rate first. The snowball method is the psychological approach, paying the smallest debts first to feel faster progress. In the example with three debts and $500 monthly payments, the avalanche method made you debt free in 21 months paying about $613 in interest, while the snowball method took 23 months and cost roughly $1,700, over $1,000 and two months more.

Q: In what order should I use each paycheck after getting paid?

The routine follows a clear order after every payday. First, separate wants from needs, keeping needs under 25% and wants below 25% of your paycheck. Second, send 20% into a high interest savings account to build a three to six month emergency fund. Third, direct the remaining 30% toward paying off high interest debt using the avalanche method. Once the safety net is built and high interest debt is cleared, that combined 50% can go toward growing your wealth through a tax advantaged investing account.

Summary & Key Takeaways

• As soon as people get paid the money disappears because they lack a paycheck routine. Being careful with money in his late teens and early 20s made the creator the first millionaire in his family, so he shares five things to do after every payday to save more and build wealth without working harder.

• Step one is separating wants from needs using six months of bank statements, highlighting repeated monthly spending, and sorting it into two columns. Needs are survival costs like rent and bills forming your financial baseline, ideally under 25% of income, while wants should also stay below 25% of the paycheck.

• Step two sends 20% of pay into a high interest savings account at a separate bank as an emergency safety net of three to six months of baseline. Step three puts the remaining 30% toward high interest debt, using the avalanche method to pay the highest interest debt first because it costs the least interest overall.