Not sure how many of you have seen the Personal Income Spending Flowchart on my lnktree, but go check it out. It’s here. I encourage you to have it open or to even print it out as you start on your journey. I’ll be walking through it. That is the TL;DR.
Investing can seem fun, scary, crazy, or something that you would’ve never thought of doing. Whatever that looks like for you, my goal is to help you get on track for retirement, and help you set yourself up for success.
But first things first… budgeting!!
Step 0 — Budget & reduce expenses, set realistic goals
Budgeting is essential to understanding where your money is going and it helps you see areas where you might be overspending. It surfaces spending trends and habits that you might want to start to control.
There are various tools that you can use, but it works best if you have a credit card and you use it for all your transactions. This way everything is logged and the tools available can sync the transactions on their end, using your information as data to visualize, graph, and monitor.
When I started on my journey, I was using a spreadsheet to keep track of my expenses and income, but this quickly became a big overhead. I discovered Personal Capital and I use it for everything: budgeting, analyzing investments, and categorizing transactions. There are also other tools like NerdWallet, Mint, YNAB, etc, but they are not all free.
Prioritize your Expenses
When it comes to budgeting, you want to account for the things that month over month you need to pay for to survive.. aka your roof, food, utilities, etc. Use this as a workflow of what to pay first or budget for first.
- Pay Rent or Mortgage
- Buy Food or Groceries (Depending on your situation or needs, you may wish to prioritize utilities before this category)
- Pay Essential items like power, water, heat, toiletries
- Pay Income Earning Expenses (these are the things you need to make money, aka your phone, your car, internet, etc. that empowers you to continue earning income)
- Pay Health Care
- Make Minimum Payments On All Debts and Loans (prioritize credit card debt and avoid missing payments, over-drafting, and buying things you cannot afford)
Step 1 — Build an emergency fund
Save for Emergencies
Your rainy day fund will come in handy some time. Meanwhile you have job security, continue increasing this fund slowly. You can keep all or part of your emergency fund in a high yield savings account so that you it can grow (albeit really slowly), but it can be withdrawn need be and it’s value will not fluctuate as much as an investment asset. Your emergency fund can be small, one months’ worth of expenses if that’s what you can start with.
Step 2 — Employer-sponsored matching funds [a.k.a. free money]
Take advantage of your employer’s free money
If your employer offers a match on your 401(k) plans contributions, contribute the full amount needed to get the full employer match, but nothing above that amount. If your employer doesn’t offer a match OR if you don’t have an employer and you worked last year OR if your employer doesn’t allow you to contribute to a 401(k) plan, consider still contributing at least 3% of your income to a retirement account like a Traditional or a Roth IRA, etc. The earlier you contribute the better because of compound interest. Here’s a calculator for that if you’re interested.
Step 3 — Pay down high/moderate interest debts
High Interest Debt
Any interest higher than 8% is considered high interest debt. Some credit cards have as high as 24% interest. If you have any high interest debt, you can consider paying it off. This is up to you and your personal financial situation as well as how debt can affect your state of being.
Increase your Emergency Fund to 3–6 Months Living Expenses
Ideally your emergency fund should be able to sustain you at your cost of living for 6 months.
Depending on your job security, you may want to prioritize this or increase it progressively.
Step 4— Savings for retirement in an IRA & higher education expenses
Consider contributing to a Roth or Traditional IRA
Always consider your financial situation. Did your income significantly increase this year? Do you have some extra money you can contribute to your retirement? What if you could reduce your taxes by contributing to a Traditional IRA and start investing in your retirement? These are all things to consider.
Comparing Traditional and Roth IRA
Find answers to
- Who can contribute?
- Are my contributions deductible?
- How much can you contribute?
- When can you withdraw money?
In short, Traditional IRAs are funded with pre-tax income, and Roth IRA are funded with after-tax income. Main difference is distributions are taxed for Traditional IRAs and tax-free for Roth.
Expecting Large Required Purchases or Expenses?
If you’re a student, your next large expense may be paying for college. Or maybe you’re planning for your first baby. Whatever it is, these are large expenses that you are expecting to be accountable for in the near future.
If you are expecting a large expense you can consider saving the amount needed for these expenses in a high yields savings account with your emergency fund.
Step 5 — Saving even more for retirement
Increase your contributions until you have reached 15% of your pre-tax income being saved if your employer offers a 401(k), 403(b), or similar retirement plan. If your employer doesn’t offer one, remember you can still make deductible contributions to a Traditional IRA, non-deductible contributions to a Roth IRA, or contribute to other retirement accounts depending on your scenario. If you’re self-employed, you can contribute to an Individual 401(k), a SEP-IRA, or SIMPLE IRA.
Step 6 — Save for other goals & advanced methods
Health Savings Account
If your employer offers you a high-deductible health plan, elect to max the yearly HSA contribution. Consult https://www.irs.gov/publications/p969.
Do you have kids?
If you have children and you wish to help finance some or all of their college expenses, you can consider investing in a 529 plan, the common name for Qualified Tuition Programs (QTPs), https://www.irs.gov/pub/irs-pdf/p970.pdf, page 59 or find “529”. These are different by state and/or institution.
If you’ve made it here, and you’re already doing everything above you can ask yourself if you have more immediate goals or if you would like to retire early.
Want to retire early?
First of all, if you’re not asking yourself this question, then ask yourself why you’re not. How long do you really want to work a 9–5 job? Maybe your response will change throughout the years, but you being financially secure will always contribute to your overall health. When you don’t have to worry about how you’re going to pay your bills for next month because you cut down on your expenses and now you have money left over for the AutoPay to kick in.. and you not have to worry because you are financially aware. Now cheers to THAT!
If you want to retire early, you can contribute to your desire to retire early by maxing out your contributions to 401(k), 403(b), or any other employer sponsored account. After that, consider the Mega Backdoor Roth IRA (a way to contribute to your Roth IRA when your taxable income puts you above the limits for contributing to the account directly), then use a taxable account.
Say you’re saving for a down payment for a home or to buy a car. You can consider putting some money away and investing it in a mix of stocks and bonds for these type of goals more than 3–5 years away. Betterment is a great tool for this.
“How do you do it?”
My two cents on all of this.. After trying many budgeting apps (Mint, Nerd Wallet) I decided on one that gave me everything, or mostly everything I wanted to see and do. My favorite tool right now is Personal Capital and has been for the past years. You can select to get an email first thing in the morning summarizing all the transactions across all linked accounts (banks, credit cards, investment accounts) for the last 3 days or so.. can you imagine how much I cried when I learned I didn’t have to scour through every statement looking for discrepancies or worse.. FEES!
In addition, I can “bucket” my purchases with custom categories and can even split a transaction and designate some part as “Reimbursable”, removing it from my cash flow as an expense. It’s just amazing, it’s free, and you should totally try it. This is not an ad. If you’re not convinced, let me know why. Oh, and that link gives you $20 for signing up.
Leverage AutoPay and never miss a payment. If you aren’t yet monitoring your credit, get Credit Karma. If you don’t have a credit card, why don’t you.. ? There. are. so. many. benefits.
Never spend more than your income. It’s that simple.
My emergency fund looks is part uninvested part invested money in different accounts and some cash. You can also count jewlery and other high value items as part of your emergency fund. Something that doesn’t lose it’s value drastically from time to time is considered an asset. You may have more money in your physical assets than you think. But also note that you would have to give up these items should need surge for your emergency fund!
Part of my emergency fund is invested (although it shouldn’t be, but I can afford the risk) through Betterment (a robo-advisor) in an individual taxable account. Using automated deposits, I add to the account every month to slowly increase my fund to meet that 3–6 months savings goal.
My employer matches 50% of 100% of my 401(k) contributions, so I elect to max it out every year, note that this might look like I’m contributing more than 15% of my income, but the goal is 15%.
I was lucky enough to not have any loans after college. Thank you MOM!
Step 4 and Step 5
I also max my Roth IRA contributions, even if I have to use the Mega backdoor Roth IRA strategy. I also contribute to other options my employer provides me with like an after-tax 401(k). DM me if you’re interested in knowing details or questions. There are many ways to maximize investing for your retirement. I’m lucky enough to have so many great opportunities to do so. If your employer offers these types of tax advantaged accounts, take advantage. They are totally worth it if you want to retire early ;)
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