In six years I went from a negative net worth to a six-figure net worth.
But it wasn’t a smooth process.
In year 1 of investing, I prioritized all of the wrong things.
By year 2, after hours of research and a lot of mistakes made, I learned there is a correct order to direct your money.
Especially if you have a goal of early financial freedom.
Each dollar you worked hard to earn should be sent to do it’s best job.
If I could talk to my past self (don’t we wish we all could), I’d share this order with her, so I'm excited to share it with you today:
1. Small Emergency Fund
I would tell myself to start small.
As you begin on your financial freedom path, one of the worst things that can happen is an unexpected expense derailing your plans.
Having this small emergency fund saves you from:
I would tell myself to start with $1,000 and place it in a High Yield Savings account (aka cash, not invested in the stock market).
It’s not enough to cover every emergency, but it will take most unexpected expenses from a financial burden to a minor inconvenience.
56% of Americans can’t handle a $1,000 emergency. Once you have this covered, you’re in the top half.
2. 401(k) Match
A 401(k) match is free money.
It’s a guaranteed return you won’t find anywhere else.
Now I don’t have a 401(k) match anymore (one downside to self-employment), but if I did it would be my top priority.
When I was employed I received a 3% match, so every paycheck I made sure at least 3% went into my 401(k).
My employer would see my 3% and match it.
That's a 100% return on investment.
A return you won’t find anywhere else.
3. High Interest Debt
Credit card debt is enemy #1 when you have a goal of financial freedom.
The interest rate will eat you alive.
Before you really start investing (outside of your 401(k) match), make sure this high interest debt is paid off.
Because credit card debt interest rates are usually in the 15-30% range.
A "return" that is hard to beat.
4. Larger Emergency Fund.
Now that you’ve taken care of the big threat: credit card debt, you can go back and build yourself more of a cushion.
The rule of thumb for a well-funded emergency fund is 3-6 months expenses.
I’d tell myself to aim closer to 3 months because at the time I didn’t own a car, didn’t own a house, and had 0 dependents.
Someone with dependents, single income household, older car, older home, or unstable job would be in the 6 - 12 month range.
5. Roth IRA
Now that you’ve built up financial security (thank you emergency fund), you can really start investing for the future.
During my first job out of college, I was making the lowest income of my career.
So it was a perfect time for a Roth IRA, which does not give you a tax deduction today but it does grow tax-free and comes out tax-free for “qualified distributions”.
I’d tell myself to open up a Roth IRA, set up automatic transfers to it, make sure it’s invested (not sitting in cash), max it out for the year. and forget about it.
This is one of your hardest working accounts, which is why you don't want to interrupt it's growth.
Next, if you have a High Deductible Health Plan, you may qualify for an HSA.
6 years ago I did not qualify for an HSA because of my healthcare plan, but I still reached out to my HR rep just to double check.
Side note: my HR rep started hearing a lot from me as I learned more about personal finance. Don't be afraid to ask them all of your questions!
Today, I've chose a high deductible health plan, which allows me to contribute to an HSA.
Check out the love I declared for this account:
7. Back to the 401(k)
If I was able to complete all of the previous six steps and still have money left over to invest, I’d go back to my 401(k) and work on maxing it out.
A decent income and low expenses are required to make it all the way to Step 7.
So it took me a while to complete all 7 steps in one year.
Keep in mind while you are starting out, completing all 7 steps might be impossible.
But that’s ok. It’s a win to complete even Step 1.
Remember the statistic on 56% Americans...