People are always wondering, “where should I invest my money first?” You have 401K’s, Traditional IRA’s, Roth IRA’s, Brokerage Accounts, Debt payoff, Student Loans, Mortgages, Hedge Funds, Crowd-Sourced Investing, hard money lending, Real Estate, Treasuries, Savings Accounts, Businesses, cryptos, and I’m sure I’m still missing some. If you ask 100 different people, you’ll probably get 100 different answers. So with all of this uncertainty, how can you ever know what to do?
While it’s easy to get hung up on finding the optimal investment strategy, don’t let perfect be the enemy of the good. You can make up for an imperfect investment strategy by being a great saver. Of course, no one wants to leave money on the table, so I wanted to give you my take.
In this article I won’t discuss the funds you should actually invest in, but rather the accounts you should invest in first. Many people think that just sticking money into a Roth IRA is all you have to do, but the account just signifies the tax treatment, not what your account is invested in. If that doesn’t make sense, don’t worry, we’ll get to that later.
1. Save a small Emergency Fund
There is a lot of debate about emergency funds. Should you have one? How much should be in it? Where should it be kept?
Having at least a small emergency fund is extremely valuable. Getting a little bit of cash to your name will help you to sleep better at night, knowing that you don’t immediately have to resort to credit cards in case of an emergency. So much of personal finance is mental, so I don’t think that we should downplay the psychological benefits of an emergency fund.
I would say at this point to start small, start with $1000. That will ensure that you can handle the vast majority of real emergencies, yet it’s not so sizeable as to slow your investment goals.
With a small emergency fund, you don’t stand to make much in interest, but I would still recommend using an online bank, I use Ally Bank, but I’m not tied to any particular company.
By banking online, you can avoid account minimum fees that the big banks love to hit you with. And you’ll get a much better interest rate, I get 1.5% right now, much better than the 0.02% I was getting with Chase.
2. Get the employer match on your 401k
If your employer offers to match 3% of your 6% contribution then it would be a bad idea to say no to that, it’s free money! You’re getting an immediate 50% return on all the money you invest, it’s tough to beat that. Invest up to the match and then move on to step 3.
3. Pay down high-interest debt
What exactly is “high-interest debt?” In my opinion, it’s considered high-interest debt if you can’t reasonably expect to get a better return by investing in the stock market, such as an S&P 500 fund.
Based on that benchmark, I would say anything with an +8% rate should be paid down as quickly as possible. That type of debt is a wealth killer and will keep you in the rat race, it needs to be eliminated at all costs! While it makes the most mathematic sense to pay off the highest interest debts first, I like Dave Ramsey’s Debt Snowball approach because it allows you to get wins early and often, which will motivate you to continue.
4. Max out your personal IRA ($5,500 for an individual or $11,000 for a couple)
You’ve gotten rid of high-interest debt, now we move to your IRA. Why go IRA before going back to your 401k? The answer, control. You fully control which funds are available and which company you use. You will get no such guarantees from your employer, and some companies have some dreadful investment options. I personally invest with Vanguard and M1 Finance, but Fidelity and Charles Schwab are great options as well.
Next, you have to decide Roth or Traditional. Do you want a tax break today, or tomorrow? I like the idea of having some of both. For that reason, I always invest Roth (after tax) in my personal IRA, and my 401k goes in pre-tax (traditional).
The rough guidance I’ll offer, what is your marginal tax rate (how much is the last dollar you earned taxed) today vs. what you think it will be in the future. If you make $200k today but only plan on living on $50k in retirement, it might make sense to invest pre-tax to avoid heavy taxes today, since in the future your tax liability will be lower.
Even though my marginal tax rate is likely higher today than it will be in retirment I still opt for Roth. I like the flexibility of knowing that I can pull out what I’ve invested without penalty. Obviously the goal is to let the money grow for decades, but life happens and it’s nice to know you have access to the money if necessary.
No one can predict the future, so you’ll just have to pick an option and roll with it. Remember, you can always adjust course in subsequent years.
5. Max out HSA- Health Savings Account ($3,450 for an individual, $6,850 for a family)
I think you could argue that the HSA could be ranked between #4 and #6, but I like it here. I think that the HSA is the single best investment vehicle, but you do need to be in a high deductible insurance plan to qualify.
I love the HSA because it’s the only money that the government will never get a piece of. Money goes in before taxes, grows tax-free (yes, you can actually invest your HSA into the stock market), and you can take it out without paying taxes as long as the money is applied to a qualified healthcare expense (which is pretty liberal).
You can roll this account over every year, and you can even withdraw the money to apply to health expenses incurred years earlier, just make sure to hold on to your receipts.
6. Max out your 401k ($18,500 per employee)
Now is the time to go back to your 401k, max that puppy out!
7. Grow your brokerage account
If you have any money left, you’ll want to start contributing to your brokerage account. This account won’t have any tax breaks, so Uncle Sam will have his grubby little fingers on the dividends and capital gains you have. That’s why it’s a good idea to save this bucket for last.
8. Invest in less traditional avenues
Of course, if you’re passionate enough about other investment vehicles, feel free to move them up the list. Some people love real estate, others wouldn’t even consider it. The goal is to invest based on your interests. And if you have maxed out everything from #1-#6 then you are in a great position to experiment and take some risks.
One such experiment I did was to invest in Lending Club, a peer-to-peer lending platform. You can read about my experience here.
Is all of this even possible?
That’s probably what many of you are thinking. Not including any money paid towards debt, if you were able to max out numbers 1-6 that would total to $27,450 for an individual, or $54,850 for a two-income household. Who has that kind of money?!
You obviously need to have a higher than average income and a good savings rate to max everything out. But that should be your goal, if you can max those buckets, you’ll be FI in no time flat! It is possible, loads of people have done it before you, so why not you?
The key is to do as much as you can, whether that’s $100 a month, or $50,000 a month. Always look for ways to grow the gap between your income and expenses and your future self will thank you.
While those options are likely the best options from a quantitative perspective, so much of personal finance is personal. You need to add your own flavor and preferences to the mix, and also keep your long-term goals in mind.
If you are very debt averse, you could consider bypassing a few of those options to pay off debt early. Be cognizant that forgoing investing in the market to pay off your 3% mortgage will likely cost you some money in the long run, but as long as you’ve considered that then proceed to do your thing. No one is more qualified to make decisions for you than you.
Hopefully, this article helps to give you a solid direction for your investment strategy and goals. If you disagree, what would be your ideal order of operations?