- Core Tenets
- Make a Budget
- Manage your Debt
- Invest in a 401(k)
- Invest in an Individual Retirement Account (IRA)
- Invest in a Taxable Investment Account
- Create a CD Ladder
- TL;DR (Too Long Didn’t Read)
- Support Me
While this document will change over time and intends to serve as a guide, there are a few core tenets that I hope you take to heart before utilizing this document’s suggestions.
You are the boss of you. Your circumstances might not be your fault, but they’re your responsibility. Sure, you’re a part of the overall economy, subject to both lucky and unlucky breaks, but ultimately you are in charge. Don’t blame anyone or anything else for your financial situation, and don’t expect somebody else to rescue you. Your financial fate rests in your hands.
Nobody cares more about your money than you do. The advice that others give you is almost always in their best interest, which may or may not be the same as your best interest. Don’t do what others tell you just because they hold a position of authority or seem to have a persuasive argument. Do your own research, get advice from a variety of sources, and in the end, make your own decisions based on your own goals and values. This applies to reading and considering the suggestions in this document!
It’s always best to be proactive. In life, there are often default options. If you don’t consciously and deliberately choose something different, you get the default. When this happens, your life shapes you instead of you shaping your life. Most people go through their entire lives in default mode. They accept what life hands them without question. They’re reactive. Don’t accept the default, proactively seek better alternatives.
The road to wealth is paved with goals. Without financial goals, you have no direction. If you have no direction, it’s easy to get off track and spend money on things you’ll regret later. But if you’re saving for a house, your child’s college education, or a trip to Europe, your goal will keep you focused, making it easier to spend on what’s important and ignore the things that aren’t.
Profit is power. To build wealth, you must spend less than you earn. This is the basic law of money. Basic, but important. Successful personal finance is all about building positive cash flow. By decreasing your spending while increasing your income, you can get out of debt and build wealth.
Saving must be a priority. Most financial gurus recommend saving 10% or 20% of your income. That’s great, but if you really want to make an impact, aim to save even more of your income. If you have to start small, start small. Even $25 a month is good. Creating that habit is important. As you earn more and develop better habits, save as much as possible. The more you set aside, the quicker your wealth snowball will grow.
The perfect is the enemy of the good. Too many people never get started putting their finances in order because they don’t know first step is the best. Don’t worry about getting things exactly right, just choose a good option and do something to get started.
Action is the cornerstone of success. It’s easy to put things off, but the sooner you start moving toward your goals, the easier they’ll be to reach. It’s better to start with small steps today than to wait for that someday when you’ll be able to make great strides. Get moving. Trust that you’ll pick up momentum in the future.
Failure is okay. Everyone makes mistakes — even billionaires like Warren Buffett. Don’t let one slip-up drag you down. One key difference between those who succeed and those who don’t is the ability to recover from a setback and keep marching toward a goal. Use failures to learn what not to do next time.
You can have anything you want — but you can’t have everything you want. Being smart with money isn’t about giving up your big screen TV or your daily latte. It’s about setting priorities and managing expectations, about choosing to spend only on the things that matter to you while cutting costs on the things that don’t. Everything’s a trade-off. Decide the level of comfort that’s right for you. There’s no right or wrong. You just have to be willing to pay the price for the lifestyle you choose.
Financial balance lets you enjoy tomorrow and today. You don’t have to choose between spending today and saving for tomorrow. You can do both. Strive for moderation in all things: pursue your goals, but don’t forget frugality; be frugal, but don’t forget your goals.
It’s more important to be happy than it is to be rich. Don’t be obsessed with money — it won’t buy you happiness. Financial success should be a side effect of a happy, productive life — not a primary aim. Sure, money will give you more options in life, but true wealth is about something more. True wealth is about relationships, good health, and ongoing self-improvement. Everything else is a lower priority.
- How do you decide what’s important and where to spend most of your money?
- If your expenses outpace your income, what can you do?
- How can you cope with unexpected major expenses?
For all these questions, a budget is the answer. Here’s how to set up a budget:
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Figure out your after-tax income.
If you get a regular paycheck, the amount you receive is probably it, but if you have automatic deductions for a 401(k), savings, and health and life insurance, add those back in to give yourself a true picture of your savings and expenditures. If you receive other types of income, subtract anything that reduces it, such as taxes and business expenses.
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Choose a budgeting plan.
Any budget must cover all of your needs, some of your wants and — this is key — savings for emergencies and the future.
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Track your progress.
Record your spending or use online budgeting and savings tools (Mint).
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Set yourself up for success.
Automate as much as possible so money you’ve allocated for a specific purpose gets there with minimal effort on your part. An accountability partner or online support group can help, so that you are held accountable for choices that blow the budget. And leave a little room in your budget for fun, too.
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Revisit your budget and tweak it as needed.
Your income, expenses and priorities will change over time. Adjust your budget accordingly, but always have one.
A budget is a plan for every dollar you have. It’s not magic, but it represents more financial freedom and a life with much less stress.
Consider using a service like Mint to aggregate your spending in major categories (rent, food, utilities, etc.) over the last six months to get an understanding of where you money is going and to average for your current behavior. This helps you get a picture of how you currently spend, and allows you to set a realistic budget and start sticking to it. Leave a placeholder for things like emergency savings and investments which we will address next.
A popular rule of thumb is the 50/30/20 budget. Let’s assume your take home pay, the cost of payroll deductions for health insurance, 401(k) contributions or other automatic savings added back in, is $3,000 each month:
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50% or $1,500 - You have this much to spend on necessities
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30% or $900 - You have this much to spend on wants
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20% or $600 - You have this much for savings and paying off debt
Your needs — about 50% of your after-tax income — should include:
- Housing
- Groceries
- Utilities
- Transportation
- Insurance
- Minimum loan payments (anything beyond the minimum goes into the savings and debt repayment category)
- Child care or other expenses needed so you can work
Separating wants from needs can be difficult. In general, though, needs are essential for you to live and work. Typical wants include dinners out, gifts, travel, and entertainment.
It’s not always easy to decide. Is a gym membership a want or a need? How about organic groceries? Decisions vary from person to person.
If you are eager to get out of debt as fast as you can, you may decide your wants can wait until you have some savings or your debts are under control. But your budget should not be so austere that you can never buy anything just for fun. Every budget needs both wiggle room (you forgot about an expense, or one was bigger than you anticipated) and some money you are entitled to spend as you wish. Your budget is a tool to help you, not a straitjacket to keep you from enjoying life, ever. If there’s no money for fun, it’s more likely you won’t stick with your budget — and a good budget is one you’ll stick with.
Use 20% of your after-tax income to put something away for the unexpected, save for the future, and pay off debt. Make sure you think of the bigger financial picture; that may mean two-stepping between savings and debt repayment to accomplish your most pressing goals.
Priority No. 1 is a starter emergency fund.
Many experts recommend you try to build up several months of bare-bones living expenses. I suggest you start with at least $500 — enough to cover small emergencies and repairs — and build from there.
You cannot get out of debt without a way to avoid more debt every time something unexpected happens. And you’ll sleep better knowing you have a financial cushion.
Priority No. 2 is getting the employer match on your 401(k).
Get the easy money first. For most people, that means tax-sheltered accounts such as a 401(k). If your employer offers a match, contribute at least enough to grab the maximum. It’s free money.
Priority No. 3 is toxic debt.
Once you’ve snagged a match on a 401(k), if available, go after the toxic debt in your life — high-interest credit card debt, personal and payday loans, title loans and rent-to-own payments. All of these carry interest rates so high that you end up paying two or three times what you borrowed.
Priority No. 4 is, again, saving for retirement.
Once you’ve knocked off any toxic debt, the next task is to get yourself on track for retirement. Aim to save about 15% of your gross income (that includes your company match, if there is one). If you’re young, consider funding a Roth IRA after you capture the company match; once you hit the contribution limit on the IRA, return to your 401(k) and maximize your contribution there.
If you have student loans, try to pay them off quickly, focusing on the loans with the highest interest rates first. This does not apply to auto loans or mortgages, consider these bills in your budget as you’ll always have these expenses.
Aim for about 3 months worth of bills. That is, post-tax, post-benefits, etc., dollars saved. For example, let’s say you earn $3,000 a month, but after taxes, medical, 401(k), etc. you have $2,000. You would want $6,000 (3 x 2,000) in a savings account as your emergency fund. Don’t take any money out of this account unless it is for an emergency (car wreck, hospital visit, etc.). Once your 3 month savings is reached, stop funding.
The beauty of an emergency fund is the peace of mind you have in the event of an unexpected expense. Will it be fun to pay for a $1,000 car repair? No. Would you rather have the money on hand rather than charge it to a credit card? Yes. Let me explain.
If you have the $1,000 up front to pay for the repairs, you avoid incurring the Annual Percentage Rate (APR) on your credit card each month. Let’s say you charged the $1,000 repair to a credit card with 24.00% APR. If you make payments of $100 a month, it will take 12 months to pay off the repair because you would incur about $134.72 worth of interest, one more month for another $100 payment and the final months for the remaining $34.72. However, if you paid with the money in your savings, you would simply pay yourself back in your budget and deposit the $100 in your savings account each month until you’re back to your 3 months worth of bills (in our example the $6,000).
Contribute at least as much to your 401(k) (if you have one) as your employer will match (if they do that). To contribute a smaller percentage than your match is to literally walk away from free money. It’s worth noting you can’t touch this money (without a penalty, at least), until you are 59½. Remember, it’s a retirement account.
In an effort to encourage retirement savings, the government created 401(k) accounts, as well as 403(b), 457, and Thrift Savings Plan (TSP) accounts for government and nonprofit employees. When you contribute part of your income to these accounts, you benefit from special tax advantages that you wouldn’t receive from contributing to non-retirement, taxable accounts.
They also include features such as allowing employers to match your contributions up to a certain amount, and also the option for you to make either pre-tax (Traditional) or after-tax (Roth) contributions. This distinction is similar to Roth and Traditional IRAs. Both account types offer unique benefits. Here are the differences:
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Pre-Tax (Traditional) 401(k): Contributions made with pre-tax income will result in a tax deduction for the amount contributed. Contributions are not counted as income, and they will lower your tax bill come April. When you contribute pre-tax, you are allowing your assets to grow on a tax-deferred basis. By the time you retire and begin to pull money out of your account, every dollar withdrawn (including the growth) is taxable as ordinary income.
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After-Tax (Roth) 401(k): Roth contributions are the opposite of pre-tax contributions. While this option may not have been widely available in the past, many retirement plans now offer it. When you contribute to these accounts, you won’t receive a tax break, but all growth and qualified future withdrawals are tax-free. Because you already paid taxes on this money when you contributed to the account, you won’t be taxed on this money when you withdraw it in the future.
The answer depends on many variables, including your current tax bracket and which tax bracket you expect to be in during retirement.
For example, if you foresee your income and earnings climbing in the future, either due to job promotions, higher income as a result of an advanced degree, or a more financially rewarding career ahead, then you may fall into a higher tax bracket later. If you foresee your income decreasing, for example if you are planning on retiring, taking some time off, or leaving the workforce, then you will likely fall into a lower tax bracket in the future.
As a general rule:
- If your current tax bracket is higher than your expected tax bracket in retirement, you should choose the Traditional, pre-tax option.
- If your current tax bracket is the same or lower than your expected tax bracket in retirement, you should choose the Roth option.
One you’ve funded your emergency fund, and invested in a 401(k), consider opening an IRA and work toward maxing it out. For 2017, the maximum contribution is $5,500. You can always check the maximums each year on the IRS website. Similar to the 401(k), open a Roth IRA over a Traditional IRA. Further, just like the 401(k), you can’t touch this money (without a penalty, at least), until you are 59½. For either IRA you choose to open, Roth or Traditional, I suggest selecting a robo advisor, specifically Betterment (sponsored link).
If you’ve funded an emergency fund, invested in a 401(k), and maxed out an IRA, you should consider opening a taxable account. Taxable Accounts have no maximum contributions, you can withdraw the money whenever you want, and you only pay taxes on your investment income in the year it was received. Consider using a taxable investment account to build wealth, as everything we’ve done up to the point has you set you up for retirement. Use this to save for your next mortgage down payment, pay for your next vacation, buy your next car, etc. Just like an IRA, I suggest you select a robo advisor, specifically Betterment (sponsored link).
Certificates of deposit, or CDs, typically have the highest interest rates among government-insured savings products. That makes them ideal for people who want to bolster their nest egg without assuming much risk. The price for getting higher interest rates is that you agree to lock in your money for a set time period. The longer a CD’s term — and the larger your deposit — the higher your rates.
I only suggest a CD Ladder to individuals who have already accomplished all previous sections. That is, you have done the following:
- Manage your debt
- Have an emergency fund
- Invested in a 401(k)
- Invested in an IRA and/or Taxable Investment Account
The reason for a CD Ladder is to have the same security as an emergency fund, but with a higher APY. A CD Ladder allows for the same liquidity of a savings account, but with greater gain through the higher APY.
A CD ladder model divides your investment evenly over some number of CDs. I’ll create an example with five CDs, with one CD maturing each year. You could opt to do fewer or more CDs, and at 6 month or 12 month breakpoints. Continuing with the five CDs example, if you had $10,000 to invest, your funds could be spread out like so:
| Term | Amount | APY |
|---|---|---|
| 1 year | $2,000 | 1.00% |
| 2 year | $2,000 | 1.50% |
| 3 year | $2,000 | 1.75% |
| 4 year | $2,000 | 2.00% |
| 5 year | $2,000 | 2.25% |
You begin seeing the payoff at the end of the first year. After your 12-month CD matures, you can reinvest that money in a new 60-month CD. When the second year ends, you can continue this pattern by reinvesting the money from your original 24-month CD in another 60-month CD. You’ll eventually reach a point where your ladder is made up entirely of long-term CDs, which earn the most interest. One CD will mature each year, meaning you can either continue investing in 60-month certificates or move the proceeds to your checking account.
At the end of the 5 years, you’ll have $11,062. Compare that to your average savings account APY of 0.06%, and at the end of 5 years your savings account balance would be $10,030. That’s a difference of $1,032. Sure, that amount of money isn’t going to change the world, but it’s free money and money that is just as safe and liquid as your Savings account if you need to reclaim it.
The Cliffs Notes to money management and investing:
- Make a budget.
- Manage your debt.
- Have an emergency fund.
- Invest in a 401(k) to maximize employer match.
- Invest in an IRA to the maximum annual contribution.
- Invest in your 401(k) to maximize the annual contribution.
- Invest in a Taxable Investment Account.
- Create a CD Ladder.
Think of these as milestones and mark them off the list once completed and move on to the next step. Steps 1 through 3 are paramount, but once complete you just have to stick with your budget and can move on to planning for retirement and building wealth.
As your income changes over time you should revisit your budget and rebalance it, if necessary, to match your needs ,wants, and savings so that they reflect your income.
When it comes to investing, Steps 4 through 8, here’s the general guide:
- Invest in a 401(k) — Grab the free money (employer’s match)!
- Invest in a Traditional IRA or Roth IRA — Max it to the annual limit!
- Back to your 401(k) — Max it to the annual limit! It’s hard to max a 401(k), but this should be your goal after getting the match and maxing an IRA.
- Invest in a Taxable Investment Account — Retirement is handled at this point, invest with the goal of building wealth through higher risk investing.
- Consider creating a CD Ladder — This provides safe and sustained growth of an emergency fund.
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