Money management is more than just knowing what stocks to buy or where to get the best rate on a home mortgage. Starting from when you get your first job, how you allocate your income will have a large effect on how much you will have later in life. Here is a strategy for making the most of your income.
Priority 1: An emergency fund of $2000: This small savings account will keep you from taking on debt when unexpected events like a car repair occur.
Priority 2: Credit card debt: Ideally you will not have any of this, but if you do, the interest rates charged will far exceed anything you can make from investing. Pay those cards off and cut them up.
Priority 3: A $10,000 dollar emergency fund: Grow your baby emergency fund into enough money to tide you over for a few months should you lose you job. This will give you the time you need to find a good job should you get laid off. If you need to use money from your emergency fund for any reason, build it back up immediately.
Priority 4: Cash for a car: Buying a car for cash is one of the best things you can do and will result in you having a few million dollars more at retirement than you would have had if you had kept a car payment throughout your life. Start with a $1500 car, save a car payment of $400 each month, and then trade up into a $5000 car a year layer. This car should last you a good seven years.
Priority 5: A 20% down payment for a home: Yes, you can get a loan for a home with very little down, but pay 20% and you will both avoid paying for mortgage insurance and reduce the chances that you will be trapped in a home should the market swoon again. Size your first home to whatever you can put at least 20% down towards – you can always trade up later. And get a 15 year fixed rate loan so that the home will be paid off before your first child enters college.
Priority 6: Retirement: Put at least 10% of your paycheck away into a 401k and/or a personal IRA. This is you r own money befrore any company matches or anything. Putting away 15% would be even better. If you max both of those out, put excess away into an investment account. Invest this money in a wide variety of growth stocks, including international stocks. Don’t withdraw this money until retirement unless you will be out on the street if you do not.
Priority 7: College Savings: People seem surprised when college costs arrive, which is odd since most babies will want to go to college about 18 years later. Put away a couple of thousand dollars each year from the time they are born in an educational IRA and then additional money into mutual funds and it will be a lot easier when they are of college age. When they are ready for college, choose one you can afford. It will matter little to most employers if they went to State U or some fancy private college. If they can’t go to the fancy school without taking on debt, they don’t need to go.
Priority 8: Student Loans: Pay off any student loans you have aggressively and get them out of your life.
Priority 9: Personal investing: Put a few hundred dollars of your income away each month for investing. Buy mutual funds or, if you have the tolerance, a few individual stocks. This money will build your income with time and also provide a fund for home repairs, buying newer used cars when your old ones are no longer reliable, and other expenses.
Priority 10: Pay off your home: Once you have a good investment stream, start making extra payments on your home and see if you can knock it out a few years early. You’ll then have another $1000 per month or so to put towards college bills or investing.
Priority 11: Investments: Once you have no car payments and no house payment, start investing the excess. Buy a rental home, then use the income to buy a second, and continue. Continue to build up stocks and bonds. Start diverting some of the income to lifestyle.
Priority 12: Legacy: Assuming your adult children have shown that they can handle money, think about giving some of it away to them each year to help them pay off their home early or put your grandchildren through college. Just be sure the gifts are welcome – they are adults and what you may think is a kind gift may be seen as an unwanted intrusion into their lives.
Also think about things like starting a trust that does something like providing money to a cause you care about or something for your descendents such as providing money for college or a down payment for a home. Set it up right and the funds can last for generations.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.