So you want to do a lot of different things with your money. You know you should save money for emergencies, but you also owe money on student loans. But someday you also want to buy a house. But you should also save for your old age. How do you begin?
The most important thing is to have a fund for emergencies. Make sure you have at least three months' worth of living costs saved up in a high-yield savings account. This is the first part of your financial plan. We put an emergency fund at the top of the list because we don't want you to go into more debt to pay for an emergency. It also gives you a sense of stability and peace of mind to know that you have something in the bank in case of an emergency.
After having an emergency fund, the next thing you should do is pay off any high-interest debt. I think of debt with interest rates over 7% as having high interest rates. The average return on the stock market is about 7%, which is why 7% is our magic number. So, if your debt is more than 7% of your income, it is costing you more money than you could make in the stock market.
So we'll put that debt at the top of our list and pay it off first. All credit card rates are high. All of them start at about 15% and go up to 30%. So you want to work on paying off your credit cards before you move on to your other goals.
First is your emergency fund, which is three months' worth of living costs in a high-yield savings account. The second step is to pay off your high-interest debt and make sure you don't get into any more. Third, you need to start saving for retirement while paying off your debts with lower interest rates. It's like getting two things in one.
We're going to do this because we want to use the time in the market to our advantage. We want to start investing as soon as possible so that our money has the most time to grow. So you want to use a tax-advantaged retirement account like a 401(k) or an IRA to start saving for retirement while also paying off lower-interest debt.
We call anything with an interest rate of less than 7% "low-interest debt." This includes things like student loans, car loans, mortgages, etc. So we kind of want to do two things at the same time. We want to start saving or investing for retirement while also paying off this lower-interest debt.
We want to keep working on number 3 and also do number 4, which I call the "big stuff." You want to start saving for the big things in life that you need to take care of first. We'll talk about getting married, buying a house, having kids, starting a business, retiring early, going on a great vacation, and starting a family. You want to save up for these big things in your life. So, once you have an emergency fund and have paid off your high-interest debt, you should start paying down your lower-interest debt while saving for retirement and starting to save for those big life goals.
Now, here's the one thing that doesn't work with this plan. We'll give it a Lion King and a half. After you save up an emergency fund but before you start paying off high-interest debt, the 1 and 1/2 is if your employer matches what you put into your retirement plan. We want you to do that before you pay off debts with high interest rates.
Because it's free money, that's why. It is the only place on Earth where you can be sure that your money will double. And an employer match means, for example, that they will match 3% of your salary. That means that if you put 3% of your salary into your 401(k), the company will match it with another 3%. They'll match your offer of 3% without you having to do anything else. They just gave you twice as much money for half as much work, so we want to take advantage of that.
So the financial game plan, this structure, is something you will always come back to. It's something you can use to figure out how to move forward with your financial goals. Personal finances can be very stressful, and we want to help you figure out what to do. We want to tell you what to do so you know where to start and how to move forward. If, for example, you already have an emergency fund, you know to move on to step two. Or, if you don't have any high-interest debt, you know to put your retirement savings first.
So, this is something you'll keep coming back to as you work toward your financial goals because it will help you set clear goals. People often come to me and say, "Well, I want to start saving money." I will ask them, "Well, why?" This gives you a clear goal, which, from a psychological point of view, will make it even easier to set and reach your goals because your brain will be on board. You are going to know exactly why you are saving money or paying off debt.
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