So you just got paid (hooray!). What do you do with that money? Obviously, it has to go to rent, car payments, debt, and bills. What about the money you have left over? Is there any leftover? Do you have a set budget? Do you need to start a budget? In the finance world, it always goes save first and then spend later. That’s how people stay wealthy. This “ladder” or order which I like to save money in makes sure to maximize every dollar so theoretically no cent gets left behind. Not having a budget can lead to mistakes which can lead to bigger consequences in the long run. Here’s how I would do it if I had to start over.

Step 1:

Start a budget. It doesn’t even have to be strict, just know where your money is going. Online services make it easier than ever, like Mint or my favorite Personal Capital. You can always do it the old-fashioned way and use Excel or even a piece of paper. Once you figure out what isn’t necessary, you can cut out that spending completely or ease up on some categories that aren’t benefiting you. Make sure you have a cushion left. Although I love reaching net 0, you never know if a surprise expense pops up and you end up with an overdraft fee!

Step 2:

Save for an emergency. The easiest way is to put aside at least $1,000. This is what’s called a starter emergency fund (in 2023 anyways). Once you get this step you’ll get peace of mind and you can move on to step 3. I recommend putting it in a high yield savings account, but since this is emergency money the more liquid (in other words: accessible) the better.

Step 3:

Apply for a work sponsored 401(k) if they offer a match. Some workplaces do $1 for $1 making your total gains here 100%. Remember only do the max match contribution for now! It’s a (almost) risk free investment since you technically get a 100% return on your money! Not just that but you also even get a tax break here since your pre-tax dollars contributed to your 401(k) don’t count towards taxable income (win-win). Workplaces now make it easier than ever to invest in funds that target your retirement date, so you can set it and forget it. Just keep an eye out for management fees the less the better.

For example, (not telling you what to buy this is just an example) VOO is a fund that invests in the total S&P 500 and has an expense ratio of 0.03%. So a $10,000 investment will cost $30 to manage over the course of a year. You won’t get a bill in the mail for $30 if you have $10,000 invested. The money is taken out of the funds gains, so in theory having a high expense ratio cuts into your future profits.

Once you start doing this your paychecks will be slightly smaller so you might want to adjust your budget again and don’t forget to keep contributing to your emergency fund!

Step 4:

Pay off high interest credit card debt. This one could honestly be higher on the list, but it’s no fun to pay off credit cards. There is no satisfaction of growth. Paying off your credit cards guarantees a 20%-30% return on your money and it’s the lowest risk since you’re guaranteed that “return”. Opt into lower interest rates with balance transfers when possible, but your first priority should be to pay these off as soon as you can.

Step 5:

Start contributing to a Roth IRA. A Roth IRA is an Individual Retirement Account (Roth) where you can contribute after-tax dollars and all profits can be pulled out tax free after age 59 1/2. You can withdraw at any age but if you withdraw profits early you will be taxed and penalized. This account has a contribution limit of $6,500 for 2023.

Scenario A: I deposit $500, it grows to $1,500
I take my $500 with no penalties. I pay taxes and early withdrawal penalties on the $1,000

Scenario B: I deposit $500, it grows to $1,500
I only withdraw $500. I don’t get penalized because those initial $500 were mine to begin with. The only catch here is that I can’t redeposit those $500 this year. Once you withdraw, it doesn’t reset your yearly contribution limit.

Scenario C: I have $10,000 in my Roth and I need the money for my first home. Pull out the money and enjoy! There is an IRS rule where you can withdraw up to $10,000 for first time home buyers. Just make sure you talk to a CPA to make sure you’re doing this right, you don’t want to be stuck paying the penalty!

Step 6:

Contribute to taxable brokerage accounts. These accounts are your typical brokerage accounts that let you invest money in the stock market. Keep in mind that any event in this account is taxable, so that’s why it’s recommended to take advantage of maxing your 401(k), IRA, or Roth first before investing in these accounts. I recommend doing both, even if it’s as small as $25 a month. Good habits start small.

Final and additional notes:

A proper emergency fund is usually 3-6 months of expenses, and it’s all based on risk. If you get to step 5 and don’t feel comfortable investing, repeat step 2 until you have at least 3 months of expenses saved. Remember, I am not a financial advisor it’s what I would do in that situation and it’s all based on risk tolerance. There are heaps of ways out there to save and invest money that I didn’t talk about in this chapter, for example a HSA (Health Savings Account) and 529 plan for your kid’s future education expenses. You should always do what’s best for your situation, and with proper planning, you’ll set yourself up for financial success.

Thank you for reading and see you next Sunday,
– Pablo