My Opinion: Planning for your financial future is one of the most important things you can do. A big challenge for many people is they don’t know what to do with their money. News about people losing money in the stock market has scared a lot of people away from investing completely. Here are some guidelines I’ve learned over the years from reading financial books and websites.
Prerequisite: The first thing is to spend less than you make. This should be obvious to most people. If you’re spending more than you make, you’ll eventually run out of money regardless of how much you make. To do this, for some, it may mean cutting back on a lot of things and for others, it may mean getting a second job, working overtime, asking for a raise, moving to a less expensive city, or getting a new job.
The more money you can save the better. Without extra money to save, the rest of the info on this page will be pointless. So be sure to make spending less than you make a priority. Once you have money you can actually save, here’s the order of where to put that money for you to consider.
1. Set up an emergency fund.
This is money for emergencies. The usual advice is to have enough money where you can survive 3-6 months in case your income stops for whatever reason. This is basically 3-6 months of expenses. Add up the total amount of money you spend per month (everything included). If you have annual expenses like property tax and/or semi-annual expenses like car insurance, just divide it up so you have a monthly figure and include that with the total amount.
Once you know what your monthly expenses are, multiply that by 3 and you’ll get the minimum amount of money you should have in a savings account. The more months you can cover, the better but 3 is the minimum. Six months or more is ideal. Make sure it’s liquid meaning don’t put your emergency fund in any sort of investment since you can’t access it right away. This emergency fund will be your lifeline in case something bad happens financially. The more months of expenses you have covered, the less financial stress you’ll have if something does happen.
2. Employer 401k matching program.
If the company you work for offers a 401k where the employer will match your contributions up to a certain percentage, take advantage of it! It’s literally free money. According to recent government statistics, just 53 percent of the civilian workforce participates in or contributes to a retirement plan. Even if your company doesn’t offer matching contributions, you still want to put money aside for retirement. Far too many people retire broke so if you don’t want that to be you, start putting money aside now. More on this later.
3. Pay off your debt.
Having debt can make life a lot more stressful. If you have a lot of debt, start paying it off. To make it simple, start by paying the credit cards that have the highest amount of interest first while paying the minimum on the other ones. Once it’s paid off, put the bulk of the money for paying down your debt towards the next highest one and so on.
Another option is to see which one is costing you the most in interest and focus on that one first. If you have a mortgage, don’t count that since you at least get some tax benefits for paying interest on your home loan. Some prefer to take on the debt with the lowest balance first since it motivates them more when they can cross a debt off the list. Do whatever works best for you. Just make sure you don’t accumulate more debt through wasteful spending once you pay everything off.
4. Roth IRA / Traditional IRA
IRA stands for individual retirement account. These are accounts you set up yourself in order to save for your retirement. There are 2 types, Roth and Traditional. The main difference between the 2 types comes down to how the money is taxed.
With a traditional IRA, the money you put into your account is pre-tax money which allows you some tax benefits when you file for taxes. Here’s an example:
Let’s say you make $100,000. If you contribute $5,000 to a traditional IRA account, it’s pre-tax money so instead of being taxed on $100,000, you’ll be taxed on $95,000 instead, saving you some money. However, when you pull the money out later on during retirement, you’ll have to pay taxes since it’ll be considered as income.
With a Roth IRA, the money you put in is after tax money. This mean you won’t have any tax benefits up front but when it’s time for you to pull out your money, it’ll be tax free. All earnings within your account that you accumulate during that time will be tax free as well. There are some exceptions so you’ll need to read up on that.
At the time of this writing, the yearly maximum contribution for these IRA accounts is $5,500 for a single person and $11,000 for a married couple. You have to have an income and pay taxes to contribute to these accounts.
I opened my account with Vanguard mainly for their low cost index funds and chose a Roth IRA account.
What to Invest in?
If you’re wondering what to put your money in, the simplest thing to do is to choose a target retirement fund. This is where you put money into a fund that is designed for your age group.
A good portfolio is one that has a mixture of stocks and bonds. The younger you are, the more time you have and the more risks you can take so the bulk of your money should be in stocks. The older you are, the less risk you should take so you’ll need much of your money in something safer likes bonds. With these target date accounts, as you get older, it’ll automatically distribute more of your money into bonds. These funds have a bit of everything from small caps to large caps to international stocks and so on so it’s very diversified.
Unless you have time to do all of the research yourself, just put your money in the appropriate target date fund. It’s a great “set it and forget it” investment. One of the biggest things when it comes to selecting mutual funds and index funds is the cost. In most cases, the lower it is, the better. Compound interest works on both your investment and those costs too. Vanguard has some of the lowest cost index funds. If you have over a certain amount, typically $25,000, it’s even lower. Fidelity and Charles Schwab are other popular brokers with low cost index funds.
5. Company 401k (no match).
If your employer doesn’t match your contributions, then putting money into your company’s 401k plan would be the next place to put your money. Currently, you can put up to $18,000 per year. The good thing is it’s automatically deducted from your paycheck so you don’t really have to think about it. Just make sure you look at what funds your money is being put into. Choose the ones with the lowest cost since low cost funds are a great indication of how well the fund performs.
6. Various Investments
Once you have money in all of the above places, you can now consider other investment options such as individual stocks, real estate, or even adding more to your emergency fund. A common mistake many people make is putting their money into stocks even when they have no money in any of the above areas. Sure, some people can have success with this but most people don’t. Be smart and protect yourself from unexpected situations first (emergency fund) followed by protecting your financial future (retirement funds).
If you’re at this stage financially, then you’re better off than the vast majority of people, even those who make more than you. You’d be surprised how many high income earnings are living paycheck to paycheck.
Getting older sucks but getting older and being broke is worse, way worse. I’ve seen people in their retirement years with no money and it’s quite sad to see. How much do you need to retire? Use this calculator to get a general idea. Just keep in mind that people are living longer and longer. If you retire at 65, you might still have another 30 years left in you. That’s a lot of years to live broke so plan accordingly.
You may currently be in a situation where you can only afford to think about surviving in the present, where planning for the future doesn’t even sound like a possibility. My advice is to make small changes. A dollar saved here and there can add up in the long run. Start by building your emergency fund so if some financially negative happens, you don’t end up living out of your car or starving yourself.