BIG FAT DISCLAIMER:
I am not a financial expert, I don’t have any formal education in finance, and I’m in no way certified to give you advice on how to handle your money. With that out of the way, I’ve been studying personal finance diligently for over 6 years and would like to pass on some things I’ve learned along the way.
OVERVIEW
It’s not always obvious what you should be doing with your money, and when. This checklist serves as a guide, telling you which items to tackle first before moving to the next. If you do your own research, which I recommend, you’ll find it’s very much in line with what the experts say. Each individual’s situation will be different, but this guide should apply to most people. I hope this helps you get (or stay) on track with your finances. Please don’t hesitate to reach out to me directly with any questions. I love talking about all things finance so I promise it won’t be a burden. Let’s get started.
1) 401k Matching
If you work for a company that offers a 401k and will match a portion of your contributions, then this is priority number 1. It is free money. For instance, my company offers a 100% match up to 4% of my salary. I have it set up where 4% of every paycheck goes into my 401k, so if that is $100 per bi-weekly paycheck, the company puts in $100 as well, resulting in $200 of free money per month. If your company does not match contributions, consider doing a small contribution of ~4% per paycheck anyway, but feel free to move on to step 2.
Some would say that step 3 should come before this. I disagree. Emergency funds should ideally never be tapped in to. Neither should a 401k (until retirement of course). If, god forbid, there is an emergency, you can always tap into your 401k, albeit with penalties. But the pros of company matching vastly outweigh these early withdrawal penalties, especially given you may never have to tap into your emergency fund, which in this case is your 401k until you get to step 3. Often it is only a fraction of your paycheck that goes into this step anyway. Ideally you will be building an emergency fund and making 401k contributions in tandem.
2) Monthly Minimum Credit Card Payments
An unfortunate number of people get trapped in this step and find it hard to meet minimum monthly payments. If this is the case, you are on thin ice and need to either increase your earnings or cut your spending. Understandably, the former is not always an easy task, but you can always cut your spending. Download an app like Mint to track your spending and identify areas to reduce expenses.
3) Build an Emergency Fund (3 Months Current Earnings)
This is perhaps the most crucial step on this list. Everyone should have a goal of setting aside AT LEAST 3 months of their take home monthly pay. If you make $3,000 per month, you should have at least $9,000 locked away in a low-to-no risk asset in the case of an emergency (car breaks down, medical emergency, loss of job, etc…). Nobody thinks these events will happen to them, until, say, a global pandemic hits and you’re out of a job for the rest of the year (too soon?). Some safe assets in which to stash this cash include: a savings account, money market account, bonds via a brokerage account, etc. Do your research on which of these options is best for you.
4) Pay Off High Interest Debt (~10% and up)
After you have a solid emergency fund stashed away you will want to start paying down high interest debt, starting with the accounts with highest interest rates. This will most likely be credit card debt, high interest student loans, etc. Consider consolidating your debt into a low interest rate with a company like SoFi.
5) Boost Emergency Fund to 6 Months Current Income
This is a good time to enhance your emergency fund savings. Aim for a goal of at least 6 months take home pay, $18,000 in the case of the example in step 3.
6) Investments outside of IRAs and 401k (Stocks and Bonds)
Some people would put this step further down the list. In reality, it depends on the individual’s situation. Here are two different scenarios and the logical breakdown of what I would do:
Anticipating large purchases in the next 10 years: Keep this list the way it is. The tax advantages of IRAs and 401ks are too powerful to ignore completely, however. In this scenario, I would suggest doing some sort of split where you put 90% of your free cash flow (all money not going towards monthly expenses) into stocks & bonds inside a brokerage account and 10% into your 401k or IRA. This strategy allows you to build up savings for those major life purchases (in the non-retirement accounts) while not totally missing out on the advantages of retirement accounts. If you switch steps 6 and 7, maxing the 401k/IRA first, then you would be putting most, if not all of your free cash flow into accounts you can’t access until you’re 59½. The max you can contribute to a 401k is $19,500 per year ($6000 for IRA – more manageable). I don’t know about you but if I were to put $19.5k into my 401k every year I would not have any leftover cash to invest in short-medium term savings which would go towards a down payment on a house, marriage, etc. If you make enough money where you can max your retirement account and still save for these large events elsewhere, then good for you! But this is not the case for most people.
Already paid for major life purchases like a down payment on a house and wedding costs: move this step between #8 and #9 in this list. If you have already paid the down payment on your home and are not anticipating large purchases over the next 10 years or so it makes more sense to max your 401k or IRA before investing through a non-retirement brokerage account.
7) Max IRA or 401k
Once you have completed your significant life purchases, like a home, you should focus on contributing the max amounts to your 401k and/or IRA. These accounts give you major tax advantages and will provide an immediate leg up versus similar investments in non-retirement accounts. Just know that you cannot access these funds until you are 59½.
8) Pay off all remaining debt with interest rates over 5%
The stock market historically provides returns of 8-12% per year when averaged over long periods over time, but if I can guarantee a return of 5% or more I will take that every time. Paying off a $1000 loan with a 5% interest rate is the same as earning 5% on $1000 in the stock market, only one of those things is guaranteed. Sure the market might have gone up 20% that year and you would have ‘lost’ 15% due to opportunity cost, but that’s something you cannot predict. 5% is my personal rule of thumb. I will hold any loans under 5% interest and pay the monthly minimums, confidently putting my money in the stock market knowing over the long haul it will return anywhere between 8-12%.
9) Creative investments like real estate (optional)
There are a number of things you can invest in outside of the stock market! Starting your own business and owning rental properties are two of the big ones. These are more aspirational endeavors, for sure, but they can be extremely rewarding. If you choose to own rental properties make sure you work with a competent Realtor who knows the ins and outs of investment properties. I just so happen to know one if you are interested.
CONCLUSION
This is a roadmap for those looking to take their finances to the next level. As previously stated, this is not a one size fits all model, but a best practices approach for the average person. Personal finance is not brain surgery. It’s relatively simple stuff that is overly mystified, exacerbated by its absence in our formal education system. The items in this list, such as an IRA (individual retirement account) can be understood within minutes of googling. So if anything confuses you just do some quick research. I hope you take a moment to reflect on this list and see where you should be funneling your money. Your future self will thank you.