Roadmap to Financial Security
Two articles ago, we covered the very first step toward financial security, having an emergency savings fund. What does the road map look like from there? Well, for an average person with a job, one can create a waterfall diagram as a guide. (I am assuming a younger professional without mounds of debt)
Extra funds from your paycheck start here at the top and flow downward. You stop when you’ve completed all of the steps or run out money. Don’t worry, in the upcoming posts, I’ll mention some ways to either increase your earnings or trim your expenses. Following this plan will be a very strong stop toward increasing savings as well as retirement accounts.
1. Pay down credit cards and other debt, which has a higher APR then available savings accounts. If debt is at 0% or very low, move to step 2.
2. 6 month’s worth of living expenses in a liquid emergency fund.
3. Max 401k* (different name for government or single business owners) up to the max amount that is matched by the employer.
4. Max Roth* Ira for the tax year. Current maximum is $5,000 per working person. (If you still have money left over for savings, congratulations, you are well ahead of the pack)
5. Max 401k up to the yearly contribution limit.
Once you’ve finished part 5 and are able to reach that point every year, you are in great shape. From this point, one needs a personally customized plan based on individual’s circumstances. One should focus on a diversified portfolio, which tries to maximize return, minimize risk and minimize tax consequences.
This plan is just an overview, which can be improved upon based on the individual’s situation, however if you follow just this plan and stick to it, you’ll be much better off then a majority of your peers (with the same earning group.)
At this point, I want to mention a very important Internet acronym, IANAL. It stands for I Am Not A Lawyer. It is used to remind the reader that it is vital to do research for yourself before blindly following advice you read on the Internet. So let me point out that I am not your: lawyer, accountant, financial adviser or doctor. Please make sure to research for yourself the recommendations, you might see that something does not fit you, or you might find a better alternative, or you might even learn something!
*401k, I’ll cover these in a later post as well, but I’ll point out that it is very important to diversify your funds in the 401k, to be aware of the fees for each fund and to make sure that you are not invested too heavily in your company stock, if it is offered.
* Roth Ira. A traditional Ira would serve a very similar purpose and if you prefer it to a Roth, that is fine too. I will cover Roth and Traditional Ira's in a later post, but my reasoning for suggesting a Roth based is the assumed young age of the professional, where their earning will only increase and their marginal tax rate will go up as they get older and earn more.