I’ve posted a lot about different tools to improve your personal finance, but I haven’t discussed the order in which people might save. In this article, I plan to go over the most accepted order to begin saving. I’ve said this before, but you should always do what you feel is best, this is a personal finance blog after all. I will give justifications for each item’s spot in the order. If you have any questions feel free to ask!
Before we get started I wanted to quickly go over the widely accepted rules of thumb for saving. Generally, you should try to save at least 20% of your income, but 30% is preferred. It is also recommended that you have at least 2.5 months in your emergency fund, but that will be covered in step 3. For more information about saving, see my article How Much Should I be Saving?
I (and many others) recommend the following as a skeleton financial plan:
- Max out your 401k/403b employer match (or, always take free money)
- Short explanation: This should be your first step after you have your emergency fund built up. 401ks or 403bs are employer sponsored tax advantaged retirement accounts and many offer matching programs. I will be referring to them as just 401ks for simplicity. This match is free money that you should absolutely take advantage of. Some employers match a portion of their employees’ contribution to their retirement accounts. Again, take advantage of this; it’s free money. Stop contributions there and move on to your next steps, this is just to take advantage of the free money. See more in my upcoming article about 401ks.
- Get out of debt
- Short explanation: Getting out of debt is a huge step towards financial independence. Being in debt means you are a “financial slave” to the companies you owe money to. You can never be truly financially free until you get rid of all the debt you owe. Debt comes before investing simply because the percent you pay in interest is almost always more than the ~6% you will be averaging in your investment growth. For more information, see my article on methods of getting out of debt.
- Build up an Emergency Fund
- Short explanation: An emergency fund is, as you might think, a big bunch of money that you have saved up to use in case of an emergency. Think of it as you rainy day fund. You should use this very rarely during your life but having it can make the difference between debt and debt free. Your emergency fund is what keeps you from going broke. A general rule is to have at least 3.5 months of expenses saved. For more information about saving and emergency funds, see my How Much Should I be Saving? and What’s the point of an emergency fund? articles for more info.
- Max out your HSA (if you’re eligible)
- Short explanation: HSAs typically take money from your paycheck before taxes (income and FICA tax free) which is phenomenal. HSAs are only available with certain health plans, check with yours to see if you’re eligible. The money can then be withdrawn tax free if used for a qualified medical expense. Most have an investment option, so your money can grow tax free as well. So they are tax free in, tax free growth, and tax free out. This can’t be beat by any other account. The annual contribution limit in 2015 for HSAs is $3,350 for individuals and $6,350 for families. See more in my upcoming article about HSAs
- Max out your IRA
- Short explanation: An IRA is also known as an Individual Retirement Arrangement (by the IRS) and as an Individual Retirement Account (by everyone else). IRAs are similar to 401ks in that they are tax advantaged retirement accounts. These plans are much more flexible when compared to employer sponsored plans (401k etc). You can invest in almost anything your heart desires (but I would recommend against doing that all the time, if at all) while 401ks are limited to what your employer allows. IRAs also have more lenient rules about withdrawing funds. The annual contribution limit for IRAs in 2015 is $5,500 ($6,500 if you’re 50 or older). See more in my upcoming article about IRAs.
- Max out your 401k
- Short explanation: 401ks aren’t at the top of the list because they are harder to withdraw from than IRAs and don’t have as much diversity in the investment options. Due to their tax advantaged status, they are still a great option for saving money for retirement. The annual contribution limit for 401ks in 2015 is $18,000. You can contribute an additional $6,000 if you are age 50 or older.
- Contribute as much as you can to a taxable investment account. See more in my upcoming article about 401ks.
- Short explanation: This is the last step! Taxable investment accounts should be saved until last because you pay tax almost every step of the way. Taxes, quite obviously, limit your future growth since they take money you could be saving instead. There are no limits on these accounts and are comparatively very few restrictions. See more in my upcoming article about taxable investment accounts.
That’s the mile high view of financial planning. I could write dozens of articles on each of those steps, but I wanted to start with the basics. Do you have any questions or comments? Let me know below!