So, you’ve started cutting back on your expenses and no longer run out of money by the end of the month. Your savings account is starting to build up. What do you do with that money? Even if you’re using a bank that’s earning the highest interest rate (around 1-2%) that’s a crummy rate of return and you can do much better.
Pay off your debt.
If you have debt other than a home mortgage, you can start throwing the excess money you have at that. Even if you aren’t paying any interest, getting your debt knocked out is a great way to use extra cash. That item will be more enjoyable to own when you aren’t paying on it each month. Better yet, sell the item and quit paying on it for good. Once you have your debt paid off, you have the money you were already saving from cutting back on expenses plus the amount of monthly debt payments.
Create an emergency fund.
Once you have your consumer debt paid off, you should get a nice emergency fund saved up. Having a few months of expenses saved changes the way you live your life. Knowing you’ll be fine for a while if you lose your job is a freeing feeling. It takes away any worry and allows you to be more creative with your career. The first thing my wife and I did with money after we got married was create an emergency fund. Thankfully, no major expenses have popped up but when they do, we won’t have to figure out where the money is going to come from.
I know I talked about how bad the interest rates are with regular savings accounts but that’s where I suggest keeping your emergency fund for now. A boring old savings account is the least volatile place to keep your money, so you can count on it being there when you need it. I’m currently using ally bank for my emergency fund and the interest rate is 1.45%. You may be able to do a little research and beat ally’s percentage. I plan to experiment in the future with different forms of storing my emergency fund to get a higher rate of return.
If you don’t have any debt and have an emergency fund in place, congratulations! You’re in better financial shape than 70% of the world’s population. You’re probably already doing the next thing on the list; investing. If you have a 401K where you work and your company matches what you put in, at least put in what the company matches because it’s free money. The company I currently work for gives me a 3% match so I put in 3% which comes to a total investment rate of 6%. I get to keep whatever growth that 6% earns. 401ks are for retirement and currently in America, you must wait until you’re 59 until you can withdraw any money from your accounts without having to pay ridiculous fees. You can however, withdraw your contributions to your retirement accounts without fees after 5 years so the money isn't completely inaccessible.
I'm certainly not a tax expert but you will need to choose between a Roth IRA or traditional IRA for your retirement account. A Roth IRA is money that you put in from your paycheck after taxes have been taken out. Since it has been taxed already, you won’t have to pay any additional taxes when you go to withdraw it after age 59. The traditional IRA is before-tax. You will have to pay taxes on anything you withdraw when you reach age 59. As far as I understand, you are taxed at your current income rate when you go to withdraw from a traditional IRA. This means if you're making $100k a year during your working career and it goes down to $50k a year when you retire, you will be taxed at $50k not $100k. Consult with a tax professional to decide what kind of IRA you should choose.
I personally only invest the match that my company gives me into my 401k. I like having more control of where my money is invested so I put most of my retirement savings into a separate Vanguard Roth IRA. The downside of investing in an individual Roth vs a 401k is the amount you can invest. With a 401k, you can invest up to $18,500 a year. With an individual Roth IRA, you can only invest $5,500. Preferably, you can save enough to max out your IRA and 401k, but I'd start with the IRA since it's a smaller goal.
Choose your funds wisely.
So what fund should you invest in? There are thousands to choose from and a lot of people just pick one randomly. What if I told you there is one index fund that you can choose that is safe and has a track record of performing at the top of the market for a long time? The Vanguard Total Stock Market Index Fund “VTSMX” is exactly that. Since its inception in 1992, the VTSMX has brought an average interest return of 8.27%. Once you have at least $10,000 invested, you can move up to the admiral shares “VTSAX” which has the lowest fees at only 0.04%. The reason Vanguard is the best place to invest is because of the low fees. Fees can take away thousands of dollars over the lifespan of your investing so you want to get them as cheap as possible.
There are other ways to invest obviously but I haven't seen any that were as cheap as Vanguard. I looked into using Betterment but their fees are much higher than Vanguard. At 0.25%, it costs .21% more to invest into Betterment than Vanguard. You might be thinking “.21% doesn't sound like much at all and Betterment has a simpler layout than Vanguard.” While it may not seem like much, it will cost you thousands over the years.
Plan for financial independence.
So, what do you do if you're like me and want to retire well before the age of 59? You shouldn't invest all of your money into retirement accounts, right? Actually, you can max out your retirements and still retire early. You're probably going to be saving a ton of money if you're trying to retire as early as possible so max out your retirement accounts to start with. Once you've maxed out your retirement accounts, open a non-retirement VTSAX account with Vanguard and start throwing as much money as possible in there. I'm sure you'll do your research and determine if what I'm telling you is good advice and come up with your own investment strategy.
Other forms of investing.
There are other forms of non-retirement investing like real estate. Real estate can be a great way to create “passive” income but unless you’re able to keep your rental properties occupied, you will have to cover the cost of the mortgage on the house. There are real estate investment companies now. If you don’t like the idea of being a landlord, you can just invest in real estate and only own a portion of the properties.
Another great thing to do with extra money is to save up for a house or pay extra on your current mortgage. You might be able to earn more money if you invest instead of paying off your mortgage early if you have a low interest rate. I have personally never heard anyone say they regretted paying off their mortgage instead of investing more in stocks though and I’ve heard quite a few personal stories about finance.
I hope you were able to get some new insight into what you should plan to do with your money. Now that you have the knowledge, it’s time to take action! Leave a comment below and let me know what you plan to do with the money you’re saving.