You’ve reached a moment in your life that has sparked you to take control of your finances. Maybe you’ve recently discovered Financial Independence, or Dave Ramsey. Perhaps you’ve even talked to a loved one about making some changes in your life to help this pursuit.
But for all the motivation and energy you have, there’s one question you still have: where do I start?
Start At The Beginning
It may seem obvious – and be an unhelpful sentiment – but really, the place to start is at the beginning. I define the beginning as really just understanding yourself. There are two fundamental questions I ask myself whenever I’m evaluating what to do.
What’s Your Current Situation
Knowing where you currently stand is super important, and surprisingly many people have no idea. When talking about financial goals specifically it’s helpful to know exactly how much money you bring in. Know how much money you spend, and what you’re saving, too.
Personal Capital is what I use to track all of this, but an Excel spreadsheet, simple pen and paper, or other online tools like Mint work just as good.
If you don’t know where you are, it’ll be really tough to figure out how to get to where you want to go.
What Are Your End Goals
Just as important as knowing what your current situation is, is knowing what you want your future situation to be. Do you want to work forever? Maybe you want to start up your own business, start freelancing, own rental properties, travel…the list goes on.
If you can’t define what you want, you’ll work toward some ambiguous goal that you may never reach. Or, when you do reach it, you won’t realize it. Take the time to really iron out what your end game looks like.
For me, it’s primarily focused on writing and leisurely travel. I dislike the idea of traveling and working at the same time, so finding a balance between those two is important for me. I know that in order to pursue writing full-time I need to continue focusing on it, getting better at it, and find ways to make more money doing it.
Your goals will be different than mine, but knowing what they are is important nonetheless.
One Size Fits Most
There’s no one-size fits-all approach for how to hit your goals. We’ve all got different backgrounds, skillsets, and risk tolerances. But, the fundamental steps apply relatively universally. It’s part of the reason that folks like Dave Ramsey have been able to find widespread success. No matter your background or current situation, a few basic steps can apply to nearly everyone.
Establish an Emergency Fund
Life happens, and unexpected expenses will arise. Having a cash buffer – commonly called an Emergency Fund – that’s earmarked explicitly for such happenings is crucial.
An emergency fund offers you some breathing room; you won’t need to put expenses on credit cards (and pay interest) if you can pay cash for them. Typical advise says $1000 is a good starting amount when you’re paying debt, but honestly this seems dated to me.
Indeed, when Dave Ramsey wrote about this years ago $1000 wasn’t even really enough then. Why was it chosen? Quite simply, it’s a semi-arbitrary amount that covers many of life’s little mistakes.
But if you’re looking for some more comfort, shoot for at least a month of expenses before you shift your focus to anything else. Burning through $1k is easy, especially at this stage of the game. Better to be a bit more prepared and pay a few more dollars in interest.
The next step is pretty obvious, too – eliminate all high interest debt. Generally anything above ~5% is a target here. Choose the method you want: debt snowball (lowest balance to highest balance), debt avalanche (highest interest rate to lowest interest rate), or the debt bonfire (whichever one lights a fire under your ass the most gets destroyed first).
Once you’re in the habit of paying off debt, it’s easy to see the money leave your checking account and your outstanding balances go down. This is great, but once you take care of all of the debt, most people struggle with what to do next.
Without a good plan, many people will just spend the money they have – even if they don’t get themselves into more debt, they aren’t really doing themselves many favors. Here are some next logical steps to take.
Max Out an HSA (if eligible)
Health Savings Accounts are triple-tax-advantaged accounts. Contributions are tax deductible, they grow tax-free, and they can be spent tax-free as well. If you have a high-deductible health plan, you are eligible for an HSA.
Here’s a trick: if you can afford the out-of-pocket health expenses, pay for health care with after-tax dollars. This will let you really maximize the growth benefit of an HSA.
Be sure to keep your receipts, and then years later you can deduct those medical expenses as needed.
Bonus for the HSA: it functionally turns into a 401(k) later. Once you hit 65, you can take the money out of the HSA, even for non-medical expenses. This is a pretty sweet benefit that is often overlooked.
If you have an HSA, use it!
Max an IRA (Roth or Traditional)
An IRA (individual retirement account) lets you stash money either pre-tax (traditional) or post-tax (Roth) for use in retirement. The contribution limits vary depending on your age and income; the IRS web site outlines all of those limits for you.
We’ve chosen Roth IRA’s for the moment to help with tax diversification, and we can take our principal out if we absolutely need to (though we don’t plan on it). There are some other advantages as well, but it should serve our needs well.
We invest in Total stock Market Index Funds. They have low fees (which I track using Personal Capital), their performance follows the S&P500, and it’s pretty brainless. They’re about as simple as you can get. If you don’t know what to invest in, but want to invest in the stock market, these are a good entry into it.
Max 401(k) (or other retirement plan)
If you’ve got a 401(k) – or other retirement plan at work – work toward maxing this out. You don’t need to do it all at once; you can slowly work your way up and increase your contributions periodically.
I chose to list this one last in the ivestment bucket, even though it should come first – at least up until any applicable company match. A company match into your 401(k) is part of your compensation plan that employers take into account. It’s free money, essentially, and is the best return you’ll likely find anywhere.
But, a lot of 401(k) plans offer lackluster fund options, have high fees, etc. For that reason, it may make sense to use an HSA or IRA first, and then circle back to your 401(k) afterward. Fees may be eating up a portion of your returns, but it’s almost certainly outweighed by the tax benefits.
Brokerage Accounts, Real Estate, Etc.
After all these other options are exhausted, if you’ve still got left-over cash, congrats! You’re in an amazing spot.
What you do from here really depends on what you feel comfortable with and what you want to do. We’ll focus on paying down our mortgage a bit early, investing in an after-tax brokerage account, and maybe look at real estate.
We also might earmark some money for a business/side hustle to accelerate our home payoff plans, too.
Get Over Your Fear and Just DO
Here’s a tip: if you can’t stomach the idea of temporarily losing money on paper, you won’t make money either.
You have to get over any fear you have. Remember: paper losses are not real losses. Unless you invest in specific stocks and they go belly-up, you should be able to ride out the storm. I’m a big fan of Total Stock Market Index Funds. These funds track the general market. So, unless the entire market goes kaput, you’ll still have some money.
Avoid selling during a down-turn, ride out the storm, and come out the other side richer.
At the end of the day, savings accounts are designed to yield a small amount of interest, not even keeping up with inflation in most cases. You need to invest your money if you ever want to stop working. The sooner you do that, and the more ways you can optimize your portfolio, the better off you’ll be.
What’s your #1 piece of advice for somebody not sure of where to start?