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The best way to gain wealth is to get your affairs in order, literally. According to experts, there is a preferred order to follow when investing your money.
If you’re not in order with your money (say, you’re pouring money into investments while neglecting mounting credit card debt), it could be a case of trying to navigate a ship that’s taking on water.
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The order varies slightly depending on the expert you listen to and your stomach for debt and risk.
But the general idea behind following a step-by-step plan is get ahead of debtTake advantage of tax-advantaged accounts, take advantage of free money, and take risks without wasting it.
1. Get rid of plastic
Don’t start investing until you’ve paid off your debt (not including your mortgage), says best-selling financial advisor, author and radio personality David Ramseywho runs the personal finance center Ramsey Solutions. Debt will hinder any investment effort, so eliminate it so you can start allocating 15% of your household income to retirement investments.
Credit card debt is crippling because it grows like a snowball. You are charged interest if you do not pay your debt in full during the month.
That means you will be charged interest on the unpaid balance the following month. If the following month is not paid in full, you will pay interest on the interest. Before you know it, the snowball is at full speed, rolling down the hill.
For example, if a borrower has $5,270 on their credit card (the average balance as of mid-2022) and is only making minimum payments at a rate of 18.17%, then it would take them more than 16 years to pay it off, according to Ted Rossmansenior industry analyst for CreditCards.com.
“And they will end up paying a total of $11,875,” he says.
Additionally, the average interest rate on credit cards is higher than ever, just over 20% on average, according to data of the St. Louis Federal Reserve. Let that sink in.
2. Pay off other high-interest debts
Next, tackle high-interest debts, such as car or student loans. Any interest that is 4% to 5% above the 10-year US Treasury rate, which has been hovering lately about 4%is considered high, according to My Money Wizard, a blogger who saved $100,000 at age 25 and whose goal is to retire at age 30.
My Money Wizard prioritizes debt reduction over stock market gains due to market uncertainty and the taxes that come with investment gains. Plus, being debt-free has its mental health benefits.
3. In case of emergency
Plan for disasters with a contingency fund.
Many experts recommend saving three to six months’ worth of emergency funds, including Vanguard Personal Investors. financial expert Suze Orman has advocated for at least eight months.
The idea is to have a cushion available in times of crisis so that investments and credit cards remain off limits.
Vanguard says However, there may be times when more than six months of savings are justified, in the face of a recession like the one imminent, or when one is in a high-turnover line of work and layoffs are not out of the question.
Just don’t save too much, says My Money Wizard: “Permanently carrying a stash of money for an improbable, once-in-a-lifetime event doesn’t make any sense. Especially considering the current abysmal interest rates.”
Read more: How can I stop the pain and make money in this nightmare market? Here it is 1 simple way to protect your savings
4. Maximize those retirement accounts
Many large companies offer a 401(k) Matching Programwhich allows you to direct a portion of your salary into an investment account, and your employer matches 25% or 50% or even 100% of your contributions, allowing you invest and make your money grow.
“It’s free money” says CPA Brian Preston, host of The Money Guy Show. “We’re talking about potential benefits of thousands of dollars a year from your employer that people just don’t take advantage of. If you can win 50% or 100% guaranteed just by participating, you are crazy not to do it.”
A traditional employer-sponsored 401(k) plan is funded with pre-tax money, meaning that any contributions made to it are not subject to taxes until the money is withdrawn much later. A Roth 401(k), on the other hand, is an employer-sponsored retirement account that uses after-tax money. When money is withdrawn in retirement, no taxes are paid.
The decision to maximize a traditional 401(k) versus a Roth 401(k) is generally a question of how much a person expects to earn in retirement. If a person expects to earn less, the traditional plan has the advantage. If they expect to earn more, the tax-free Roth has the advantage. The same applies to individual retirement accounts (IRA).
5. Taxable Brokerage Account
It’s time to take some risks you can afford to take.
A brokerage account provides the flexibility of retire early or take advantage of the money you might need for a golden opportunitysays financial analyst Bo Hansen of the Money Guy Show.
Unlike your tax-deferred retirement accounts, a brokerage account will be subject to capital gains tax as it increases in value. But the advantage is that the brokerage account has the flexibility to allow withdrawals at any time, without incurring a penalty in the form of taxes, which are assessed depending on how long the asset was held.
“After-tax money is liquid money that you have easy access to… This is the stage where you can buy a better car and travel better,” Preston says.
You also can use that cash to create margin or opportunity.
“I load mine with index funds and other things, and it’s still very easy to access. “It is a great tool for generating wealth,” she says.
6. Pay off your mortgage
This one comes with a warning. If a homeowner took advantage of a low interest rate, it might make sense to invest in something like an index fund instead of pay the mortgate right away, says My Money Wizard.
This is because the stock market can typically outperform any mortgage by 3% to 4%. But if he mortgage interest rate goes up, so paying it off before investing may make more sense.
If you feel happier being completely debt-free, it might be worth it. Preston’s advice is to ask yourself what the “why” is.
“My goal was to be completely mortgage-free by age 50,” Preston says. “The problem I have is that I have a 2.5% mortgage and I only owe $200,000 on the house…. But the problem is that my cash pays me a little more than 4.3%. You can see I have a dilemma.”
All in all, it’s a pretty good dilemma.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.