I entered adulthood with bad spending habits. While we are taught how to manage money as a skill in the culture of the middle class (and how to build wealth in the culture of upper class), in the culture of poverty we learn that money is for spending. I started college not knowing how credit cards work, which made me a perfect target for all of those college credit card offers. Quite frankly, I got my first credit card on the same day that I got my first checking account. Not exactly the greatest foundation for a sound financial future.
I share all of that as a reminder that we all start somewhere. Where you are now matters far less than the power you put behind your plan for the future. That’s what I learned from first hand experience, and it all started with a priority list I created for how I would invest. I decided I would share my list with you. Feel free to use it as is or adapt it as you see fit.
401(k) Up to the Company Match: “It doesn’t matter if you are in debt, and it doesn’t matter if you have not yet saved for your emergency fund. You must invest up to the company’s 401(k) match no matter what.” That’s what I was told by a financial adviser that I met through the Women’s MBA Association, and he was right. If you do not invest in your 401(k) at least up to the company’s match, then you are leaving money on the table. Plus, the 401(k) is a great way to start investing because it invests money before you ever see it, and if you don’t see it you can’t spend it. If you are self employed, then you would want to look into the Simplified Employee Pension as an alternative. If you are a stay at home spouse, then you will want to consider the Spousal IRA.
Take a Look at Debt: This is when you want to pay off all of your high interest debts. Here I speak specifically about credit cards and personal loans. Subprime auto loans have also been making the news recently, so I now consider those high interest car loans as a high priority pay off item as well. I have been asked before whether you should pay off debt or save an emergency fund first. In my opinion, if you have high interest debt then you get a higher return by paying off the debt because you will be losing money faster than you can earn it with investing. I also like to pay off the debts in the order of highest interest rate to lowest interest rate (ensuring that you are paying the minimum due on all debts each month, of course).
Emergency Fund: Now that the high interest debts are paid off, you can start preparing for an emergency. Financial advisors vary in their opinions on how many months of salary you should save in an emergency fund. Suze Orman says up to nine months while many others say as low as three. My advice is this: start by creating an emergency budget. This gives you a realistic sense of how your spending will change if you, for example, lose your job. For those of us who have been unfortunate enough to lose a job in the past, you quickly realize how much money you save by not working. Jobs are expensive. However, there are still bills that need to be paid regardless. Create your emergency budget accordingly. Then go step-by-step in terms of saving. First save for one week, then two, then three. Soon you will have your first month of emergency expenses saved up. Then move on to saving the second month. Leave room to congratulate yourself and do a little happy dance at each iteration. Ultimately, it is for each of us to decide our comfort level where the emergency fund is concerned. I stick with Suze Orman’s 9 month emergency fund advice but it is based on my emergency budget expenses.
Roth IRA Up to the Maximum: Once the emergency fund was created, I had room to continue to invest in my future. Next on the hit list was the Roth IRA. Unlike the 401(k), the money you invest in a Roth IRA has already been taxed. What that means is that, under current tax law, when it comes time to take the money out during retirement (after the age of 59.5 years of age) you do not get taxed again. Tax free interest earnings! Also, while you can’t withdraw the interest without a penalty before the age of 59.5 years, you can withdraw any of the post-tax dollars you contributed to the Roth IRA without a penalty. In that way it acts like a second emergency fund. You can contribute to a Roth IRA up to the point that you make $114,000 as a single person or $181,000 as a married couple. You can contribute up to $5,500 per year in a Roth IRA. I have my contributions withdrawn from my checking account automatically on a monthly basis to keep me honest.
Head Back over to the 401(k): Once you are able to maintain your monthly Roth IRA contributions comfortably up to the maximum allowed ($458.33 per month), it is time to head back over to that 401(k) and incrementally increase your investments up to the maximum allowed under tax law. As of 2015, that new amount is $18,000 per year (or $1,500 per month). If you are over the age of 50, then you can also make “catch up” contributions of up to $6,000 more per year. I believe one of the best ways to save for the future is to invest that money before it ever hits your checking account, and the 401(k) is a good option there. The 401(k) also becomes attractive from a tax standpoint because it lowers your taxable income. Among other benefits, this tax break helps you qualify to contribute to a Roth IRA until you make $132,000 as a single person (technically) because your taxable income will stay below that $114,000 mark if you contribute $18,000 of your pre-tax income in a 401(k).
Start Paying Down Other Loans: I consider this brand of loan, with items like mortgages and student loans, to be investments in and of themselves. I am in the process of refinancing my condo. Eight years ago I got a 30 year mortgage on our condo for $62,000 (factoring in our downpayment), but I have been paying it like it is a 15 year loan. I decided to refinance the balance as a 7 year loan with a 2.8% APR before interest rates start to climb. I’m able to afford to pay the mortgage off more quickly because I didn’t fall victim to lifestyle inflation by buying a big house as soon as I could afford one. This, more than anything else, is what has freed me up to invest in my future. Similarly, I paid $60,000 to get my business degree at a private school. I had the option of paying that off in 30 years, but I did not want to still be paying that well into retirement. So, I have been paying it like it is a ten year loan. Although this was a big investment, my “honest with myself” research into my expected salary upon graduation and five years after graduation made the investment worthwhile. Since I lease my car, those are my only two debts.
Invest in “Taxable” Accounts: This is where I am at now on my list. Taxable accounts are those investment options, like mutual funds and the like, that do not come with the tax benefits of the 401(k) and Roth IRA. When you make money from these investments you are taxed on any money that you make from them (referred to as capital gains). The other way to make money in taxable accounts is by saving money by sticking with low fee funds. When you buy into a taxable account you are not only paying to invest but you are paying finance fees in order to pay the folks that are “managing” the fund. They use their finance degrees to decide what mix of stocks and bonds to invest in, and the finance charges for different funds vary widely. You can always invest in stocks, but I’m not a fan because it’s important to “diversify” by investing in lots of different stocks and bonds in case one tanks. I’m a fan of “index funds” since they are low cost, and I am a super fan of the NASDAQ index fund since I work in and like to support innovations in technology.
529 College Savings Plan: I am a big believer in the idea of putting your own mask on before assisting others. I do not have children, but I can say that I do not believe I would pay for their college education if I did. I believe that many in the middle and upper class join the workforce with expectations of having things handed to them that are a detriment to personal growth. However, all investment decisions are individual, and your beliefs can differ from my own and still be right. Now that your own investments are in order, you can look towards investing in your child’s education. You can also use 529 plans to invest in your own education as well.
Given where I started in life, it is hard to believe that I have come this far in terms of my investments. The reason I started this blog is because I truly believe that anyone can get their financial house in order. I believe it because I have had a driver’s seat view of what is possible when you have a good plan.