OK, so you’ve got a job and make money. You’ve arranged your life so that you can afford your bills every month (That’s a big whoo-hoo right there.) But now you’re wondering what you need to do to get on the Path to Wealth.
We’re talking real wealth, not blingy show-off a Gucci bag but have zero in the bank “wealth.”
Wealth so that you have financial stability, the ability to happily retire and live comfortably in your older years, and even pass on to your heirs (kids) or charitable organizations if you choose.
Dave Ramsey has his “Baby Steps” for paying off debt.
The Money Guys have their “Financial Order of Operations.”
I am not reinventing the wheel but I have taken bits and pieces from them and many others to create my own Path to Wealth.
Here’s a step-by-step guide to help those who want to get wealthy, decide where to put their next dollar.
Step #1: Save for Semi-Regular Bills and Deductibles
Every month you pay your power bill, rent/mortgage, etc. But how often do you pay your Car Registration or Maintenance, Rental Insurance, or large medical bills?
These are predictable bills that come up, some, like clockwork, every year, or every few months.
They still manage to throw many people off guard, causing big financial burdens. Put money away for Expected Expenses every paycheck, as if they are any other regular monthly bill.
If your car registration is about $300 a year, divide that by 12, and put $25 into your designated savings account every month, separate from your other accounts.
When it comes time to pay it, you already have the cash available.
The account will build up every month (hopefully with a little interest if you get the right bank). It will give you peace of mind knowing that your not-so-surprise expenses are already paid for.
Just make sure not to raid this account for other things, this money is technically “already spent.” I use the “nickname” feature most banks have to put what the monies in that account are being saved for.
Step #2: Employer Match
If your employer offers an Employer Match for your 401K, TSP, 403(b), or whatever retirement account you have access to and you don’t take advantage of it, you are literally throwing money away.
Your employer match is money that your employer has set aside, specifically, to pay you in your retirement account, it is part of your salary.
But if you don’t put your own portion in the retirement account every check, your employer gets to keep this money all to themselves and you get squat.
Find out from your HR department what your employer match is.
If it’s 3%, that means if you have the company put 3% of every one of your paychecks into the account, your employer will also put in the same amount of their own money every paycheck.
That’s a 100% return on that money! You can’t get that anywhere else!
Often that 3% you put in is pre-tax as well, so you won’t even notice it missing and you get a tax deduction.
If you are just starting a new job, get your 401K set up immediately. You will never have seen that money in the first place, so you will never miss it.
Invest it simply and let that money grow and grow over your working years.
If you change jobs, you can transfer this money to an IRA.
Just don’t withdraw it until you’re 59 ½ years old unless you have an absolute real-life emergency, that would trigger all sorts of taxes and fees that you don’t want to deal with.
Remember this money is so that you can have a comfortable retirement in your old age.
Step #3: Build a Starter Emergency Fund
(If you don’t have any high-interest debt, Step 3 will quickly melt into Step 5)
Now, if you have high-interest debt, like credit cards, you are first going to want to save up a starter emergency fund, aim for $1000.
If you’re having a hard time keeping up with your bills, this in itself can be a big accomplishment!
Work on saving this up as fast as you can so that you have the buffer you need in case new “emergencies” AKA LIFE HAPPENS.
You get a flat tire, your kid chips a tooth and needs an emergency dental procedure, your refrigerator breaks down, instead of having to whip out a credit card and create more debt for yourself, you will have this money to draw from.
Like in STEP #1, you are expecting these types of bills and pre-pay for them in a way with your savings.
If you end up having to use some of your emergency fund, which always inevitably happens, hit pause on your extreme debt payoff of Step #4 to refill your emergency fund.
Step #4: Paying off High-Interest Debt
47%, almost half of Americans, carry some form of high-interest debt, so if that’s you, know you’re not alone.
But also know that you want to get rid of it now!
The interest you pay to credit card companies is money that you don’t have to spend or save for other parts of your life.
The average debt consumer has about $5,000 in credit card debt. The average interest rate is about 15%.
If that debt does not get paid down ASAP, the average consumer will have paid about $750 in interest alone in one year.
I’m sure you can think of much better things to do with $750 a year than just give it to a credit card company.
So once you have Steps 1-3 covered, you need to treat your high-interest debt payoff like your hair’s on fire! Get it done as fast as possible. Here’s my article on debt payoff.
Take on a temporary part-time job or sell extra stuff in your house you don’t need. If it’s really bad, move back in with your parents to save on housing expenses, if that’s an option.
Do whatever you need to do to get rid of that weight in your life! High-Interest debt is a burden you don’t need holding you back. Do whatever you can to get rid of it.
Low-interest debt, like a mortgage you can comfortably afford, can often allow you more opportunities to advance in life. These are not as much of a hair-on-fire situation and will be addressed in the last step.
Step #5: Long Term Emergency Fund
Many people tend to separate Steps #5 and 6, I believe they can be done at the same time, but if you are not comfortable doing both steps at the same time, do 5 first, Fund your Long Term Emergency Fund.
Long term can mean different things to different people.
Your long-term Emergency fund is what you’re going to have saved up in case of a larger event.
Not just a flat tire or doctor’s appointment, but an unexpected job loss, family medical emergency, or worldwide pandemic which we all had such an exciting time with recently.
How quickly you could find another job? Do you have a spouse with a job that could also cover household bills? What types of savings and resources do you have available to you?
Your long-term emergency fund should be somewhere between 3 months and a year’s worth of expenses, depending on your personal situation.
This size of an emergency fund can take a while to build up, so work on it, but give yourself grace to also do step #6 at the same time.
It is so important to give you peace of mind, knowing that you, and your family, will be able to weather a financial storm.
Step #6: Invest in an Individual Retirement Account (IRA or Roth IRA)
Like I said in #5, these steps can be done at the same time because they both take so long and are both so important for your long-term financial health.
A Long Term Emergency fund protects you today, in case of just that, an emergency, but an IRA protects you in the future, allowing you to have a secure retirement in your later years.
The reason it is so important to save in an IRA as early as possible is because of the power of compound interest.
The money you put away and invest today will have the time it needs to grow exponentially by the time you need it in retirement. Just a little bit put away today, can have huge growth over the next few years.
Putting away just $100 a month in a low-cost index fund, like Vanguard or Fidelity, that earns an average of 7% interest, you can have over $120,000 in 30 years. Or $260,000 in 40 years. That’s just a night out with your significant other at Chipotle once a week.
Imagine how quickly your money can grow as you get promotions at work and put away monies from other places.
It only takes $380 a month, for 40 years, at 7% interest rate to get to $1,000,000. Considering the average adult’s working career, that’s pretty good. If you want to retire faster, find ways to stash away more in the next 2 steps.
As of 2021, the maximum amount you can put into an IRA is $6,000 a year or $7,000 if you are 50 or older. Thus, once you manage to max out your IRA, move on to Step #7.
Step #7: Max Out Your Employer Retirement Account
You’ve already made sure you’re getting your maximum employer match at work, have a good emergency fund saved up, paid off all high-interest debt, and maxed out your Individual Retirement Account. If you still have some extra money at the end of the month, whoo hoo!
Now, what can you do to maximize your tax savings and build real wealth for your future?
Go back to your Employer Retirement fund (401K, etc.) and max that out!
In 2021, the maximum 401k contribution is $19,500 for people under 50 and $26,000 for people 50 and older.
Depending on what tax bracket you’re in and what options your employer has, you can work on maxing out your employer retirement fund in a Traditional or Roth Account (discussed here)
Step #8a: Stock Up After-Tax Brokerage Account
At this point, you’re out of debt, have healthy savings, and are maxing out all of your tax-advantaged retirement accounts.
Now is when you have to make decisions, based on your own life, your own priorities, and your own goals. The 3 Step #8s can be moved around to decide what your top priorities are.
Stocking up extra monies into an after-tax low-fee brokerage account can supercharge your wealth. It gives you yet another place, after your retirement accounts, to use the power of compound interest to grow your money.
If you are looking into joining the FIRE Movement (Financial Independence Retire Early) you may want to look into actually investing part of your Step #7 money into an after-tax brokerage account.
Normal retirement accounts often require you to wait until 59 ½ years old before you can access it (there are exceptions but not as easy as just doing this) so if you are planning to retire before 59 ½ make sure you have money that will be available to you before standard retirement age.
Step #8b: Pre-Pay Future Expenses
This step depends on your own life situation and beliefs.
If you are sure that your retirement will be well covered, (check out this calculator) you can use this opportunity to save for future expenses.
This might include college savings for your kids, saving to buy a dream speed boat, or planning for an ultimate trip around the world.
Whatever important purchases you want to make in the future should be saved for AFTER you are sure that your current and future selves are covered.
After all, your kid can find part-time work, loans, or scholarships for college, but you don’t get scholarships or loans for retirement. Once you reach a certain age, part-time work may no longer even be an option.
Take care of yourself first so that you know you won’t become a burden on your kids, then you can work on helping them cover college or house down payments.
And if you don’t have any kids or don’t plan to help them with college expenses (who knows that options might be available in a few years) you might not even have to worry about this step, just keep pumping away at the other #8s.
Step #8c: Pay Off Low-Interest Rate Debt
Again, this totally depends on your lifestyle and what makes you comfortable.
Low-interest debt usually comes in the form of mortgages or maybe student loans.
Some people HATE having their mortgage or student loans looming over their heads and just want it gone. They may work on this step before they dive into #8a.
Mathematically, it may make more sense to keep paying a low 3% interest rate on your loans so that you can invest the difference and make 7% in index funds. But some people just can’t stand the thought of owing money and want to pay it off to just be done with it right away.
This is also a good option if you are getting close to retirement. Retiring with ANY debt is not fun.
Owning a mortgage-free home just feels like a breath of fresh air. Some people like the freedom to move that renting gives them and never have to worry about this low-interest debt in the first place. As I said, it all depends on your life and how you want to live it.
Wrap-Up
I know that was a long post and I thank you for getting through it with me. When deciding what to do with your next dollar, follow this Path to Wealth and live the rich life.
Here they are again in case you want the short version:
Path to Wealth
Step #1: Save for Semi-Regular Expenses
Step #2: Get Your Employer Match
Step #3: Build a Starter Emergency Fund
Step #4: Pay Off High-Interest Debt
Step #5: Build Your Long Term, Emergency Fund
Step #6: Invest in an IRA
Step #7: Max Out Your Employer Retirement Account
Step #8a: Stock Up After Tax Brokerage Account
Step #8b: Pre-Pay Future Expenses
Step #8c: Pay Off Low-Interest Debt
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