If you follow these 10 steps for investing your money, you will be a more efficient investor than the vast majority of people.
Why? Because most of us are short-sighted and lazy when it comes to our financial choices. We tend to either fixate on one idea or spread our hard-earned money across different investment vehicles, arbitrarily.
Investing in the right order will unquestionably save you money in the following ways:
- Better tax-efficiencies (keep more of your money from the government)
- Better cost-efficiencies (keep more of your money from the investment providers)
- Improved financial stability (protect yourself from unexpected costs and secure your future)
- Increase your income (get more money from your employer)
- Lower debt repayments (clear high-interest debt faster)
Before you invest, take stock of your situation
When you’re just starting out with investing, it’s hard to resist the urge to dive headfirst into the exciting stuff:
- Opening an investment account
- Picking stocks & funds
- Watching your money pile grow.
But before you can do that, you need to understand your financial situation, pay off debt, and make sure the basics the covered.
We accordingly don’t start our ‘real’ investing until step 6 – so be patient here.
The personal finance flow chart
All of the following advice has been condensed into our personal finance flow chart.
It might seem strange that every financial decision you make can be condensed down into a flow chart, but I promise you, it’s true.
Follow this flow chart, and you’re golden.
Step 0: Create a budget & set your goals
Before we start climbing the ladder, let’s first understand what money we’re playing with.
We need a budget.
Don’t panic here, a budget does not need to be complicated.In fact, we encourage you to keep it simple.
But it must be done.
How can you invest effectively and consistently if you have no idea how much you are able to invest each month?
A good place to start is the 50/30/20 method to allocate your money.
That’s 50% of your money going towards Needs, 30% going to Wants, and 20% going to Saving & investing goals.
Another option is to simply list your regular income and expenditure (in a spreadsheet or on a piece of paper).
Get an idea of how much money you have available for spending, saving & investing.
You should also start to think about your financial goals, as these can inform your budget and investment allocation:
- Do you want to save for a house, a car, a wedding, or another short-term goal?
- Do you want to retire early?
- Do you simply want to be financially independent?
These are your life goals, so don’t take this step lightly.
Step 1: Create a small emergency fund
Life comes at you fast and there will be sudden, unexpected costs in your life:
- Car problems
- Dental issues
- Veterinary bills
- Job loss
- Many more!
An emergency fund is precisely for these types of situations.
Start by creating a pot of 1 month’s salary in a checking account, or an easy-to-access savings account.
This is your safety net.
Note: your investments are not your emergency fund. Investments are volatile; there’s no guarantee they will be up when you need them to be. Moreover, selling them takes time – too long in the case of emergency.
If, at the end of every month, your bank account is zero, that means any sudden emergency expense has the potential to ruin you financially (go back to step 0 and create a budget if so).
An emergency fund therefore has the additional benefit of preventing you from making poor financial decisions, like taking on debt in the form of a loan or a credit card with high interest rates.
But by far the best reason to create an emergency fund is to combat money stress.
Money stress affects more than half of us every year, and having a financial safety net is also a mental safety net.
Whether you consciously feel it or not, the stress of not knowing whether you can pay the bills this month can eat at your mental and physical health.
Before you invest your money, invest in an emergency fund & your peace of mind.
Step 2: Retirement accounts – Employer matching
Most companies are willing to give you more money simply by you sacrificing more of your income into a pension. You can quite literally increase your income by taking advantage of this scheme.
If your company offers a 401(k) or similar retirement account, make sure you are contributing the full amount needed to get the full employer match.
For example, if you need to contribute 5% of your income for the company to contribute 5% too, then do it.
If not, you’re leaving free money on the table:
- With employer-matched contributions, you receive an immediate 100% return on your investment. For every $1000 you contribute, you get $1000 from your company.
- If that wasn’t reason enough, know that this is money that you contribute pre-tax, therefore reducing your tax burden. It’s one of the greatest tax advantages you can utilize.
- Finally, this is money that can grow significantly when invested over a long time period, leaving you with a nice retirement pot. Check out the power of compound investing with our calculator to see just how much it can grow.
Before you consider any other types of investing, make sure you are investing into a retirement account like a 401(k).
If you’re not sure if your company has one, ask your HR or Benefits Manager if they have an employer-match and how it works.
Taking advantage of your 401(k) or similar product, is the minimum you can do.
The next step is to make sure the fund you choose for your retirement money is the right one. Don’t simply take whatever default fund you are given.
Make sure it has low fees, is globally diversified, and the right balance of stocks and bonds. You can read more about picking a solid index fund here.
Step 3: Pay-off high interest debt
Before you invest in the stock market, you need to check your debt agreements.
That includes loans, credit cards, car financing, student loans and so on.
You might get a better ROI (return-on-investment) from paying off your debt than you would from the stock market.
Let’s say for the sake of argument you will get a consistent 10% return from the stock market, but you have $1,000 of debt with 15% interest.
If you invest $1,000 in the stock market, next year, you will have $1,100 dollars.
But your debt will have risen to $1,150, meaning a net loss of $50.
Instead, pay off your $1,000 debt before you start investing in the stock market.
Personally, I would prioritize paying down any debts with an interest rate of 6% or higher before beginning to contribute to my investments.
You may have one large debt or multiple smaller debts split across credit cards & other loans.
If it’s the latter, you have two options for paying down the debts:
- The snowball method, where you pay off the smallest debt first. This is the best psychologically, as you get to see the number of debts you have fall faster.
- The avalanche method, where you pay off the debt with the highest interest first. This is best financially as you will end up paying less overall.
There really is no right or wrong answer, do whatever works for you.
Step 4: Create a larger emergency fund
Yes, I’m afraid we’re still not ready to invest just yet.
The 1-month emergency fund you built in step 1 was your first safety net. Now, you need to cast that net wider.
Aim for 3-6 months of your salary saved in an easy-to-access bank account.
This amount covers the vast majority of unexpected expenses.
Cash is eroded in value by inflation over time, so you probably don’t want to keep more 6 months’ worth of salary in cash unless you are saving for a short-term goal.
Your money is better served invested in the market, where it can grow.
Step 5: Assess your short-term & long-term goals
Now you are at a crossroads.
What are your goals for the money you are investing? More specifically, when will you need the money?
If your goals are short-term, less than 5 years, investing is most likely not for you. A high-interest savings account would be best.
That’s because investment returns are not linear. It is a bumpy ride.
Some years your investment will be up, some years down. But over a long enough timeframe, the market has always returned.
This means that your investment horizon should really be at least 5, but ideally 10 years.
Investment success is measured in decades.
If this comes as a shock to you, you need to adjust your attitude towards investing. There are no get-rich-quick schemes.
If your goals are longer term, move to step 6.
Step 6: Investing in a Roth IRA
The Roth IRA is a tax-advantaged investment account.
Other than fees, taxation is the biggest threat to your investment return. Shielding your investment inside tax-advantaged accounts like the Roth IRA, means that you can keep more of your investment return.
The Roth IRA can be filled with your after-tax dollars and withdrawn penalty-free just before you turn 60.
That means at 59 ½ years old, providing the money has been in the account for at least 5 years, you can withdraw the money tax-free.
You should invest the maximum amount, which is currently $6,500 for 2023 ($7,500 for over 50’s).
You must be earning an income to contribute and earning no more than $153,000 as a single person or $228,000 in a married couple.
Step 7: Increase 401(k) contributions
In step 2 we talked about employer-matching for your retirement accounts. That is, contributing the minimum amount needed to get the full match from your employer.
But you don’t need to stop there, and you absolutely shouldn’t.
That’s because your retirement account is a fantastic tax-advantaged vehicle. Because you are investing your pre-tax dollars, you can invest more capital.
For 2024, you can contribute up to $23,000 a year ($30,500 for those aged 50 and over).
Strive to contribute as much as you can. If you’re not sure where to start, aim for 15% of your income at a minimum (including the employer contributions in this calculation).
Step 8: HSA (Health Savings Account)
If an HSA is an option for you, then it is a great option for paying for future health expenses.
You must be covered under a qualified high-deductible health plan (HDHP) before you can contribute to an HSA.
It can lower your costs for eligible medical expenses right now and can also be used to save for future health care costs, and even retirement.
It has three key tax benefits:
- Your contributions are tax-deductible.
- Your money grows tax deferred.
- You can withdraw tax-free as long as it is to pay for qualified medical expenses.
For 2024, you can contribute $4,150 if it’s for yourself, or $8,300 on a family plan. You can contribute an additional $1,000 if you’re over 55.
If you use HSA money in retirement to cover eligible expenses, it’ll be tax-free. But if you use it for other purposes, you’ll just have to pay regular income taxes.
Step 9: 529 education savings plan
If you want to save for a child’s college education, you should consider a 529 education savings plan.
It’s like a Roth IRA, but for education expenses.
Contributions are made on your after-tax dollars, but the growth of the investment is not subject to federal tax and often state-tax too (when used for qualified education expenses).
There are no annual contribution limits, but be aware that you can only contribute up to $17,000 a year per beneficiary without triggering federal gift taxes.
There is a 10% penalty if withdrawing for other purposes.
However, new to 2024, if you have had your account open for at least 15 years without changing the beneficiary, you can roll over the money to your Roth IRA penalty-free up to $35,000.
The Roth IRA annual limits still apply, so you would have to roll-over the $35,000 over a few years.
But it means that 529 plans are now more attractive due to their flexibility should you choose not to use all the funds in that account for education or there are simply leftovers.
Step 10: Taxable investment account
After you have maxed out all your tax-advantaged options, you will need to open a taxable account.
This is your last resort, as these government taxes on top of your normal investment fees will eat away at your wealth over time.
By the time you reach step 10, you’re on the road to a high net worth.
This might be the time where a financial advisor can add value to you or where you might start exploring other investment opportunities like real estate.
Our advice? Stick with passive index funds.