I’ve Got Disposable Income, Now What?
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I want to preface this post with the notice that I am by no means a professional financial planner and this post should be taken as a guideline, not a hard and fast rule. Everyone’s situation in life is different, and if you are worried about your own financial wellbeing, you should consult a professional. With that being said, I felt this would be a great intro post into the financial side of my blog. Personal finance is a topic I’ve become really interested in over the past couple years and I continue to learn something new in the field almost daily it seems. So, I figured what better way to teach others than to share my own personal learnings along the way! This post is aimed at younger adults just fresh on their financial journey, but could absolutely be used as a guided path for people of all ages who just want to get their finances in order. Let’s dig in.
Get Out of Debt!
Looking back, one of the scariest moments for me out of college was getting my first real job. No, not because I was finally on my own or because there was the risk of losing said job. I didn’t know it at the time, but the biggest hurdle for me was not blowing all that money I now had on junk I didn’t need. I made the mistake of purchasing a brand new car right out of college and, what’s worse, I got a loan to pay for it 😬. So, I’m going to kick this off with my first piece of advice, DON’T GET INTO DEBT! If you are already somewhat in debt, your first goal should be to pay down as much of that as you can, as quickly as possible. Some would argue that a little debt can sometimes be a good thing, but since I’m assuming you are just starting out, I’m going to recommend you don’t go down this path until you are more comfortable with your income and expenses.
Now that we’ve gotten that out of the way, what’s next? You have a job, with disposable income, and don’t know what to do with it. My initial suggestion would be to head straight over to your HR department and find out if they offer any sort of match on a 401k. If they do, that’s your first move! Some companies offer a generous match to your own personal contribution toward a 401k, up to a certain percentage of your income. It would be foolish of you not to take them up on this offer, since it’s essentially FREE MONEY! 💵
After you’ve taken advantage of that sweet deal, it’s time to start putting money away for a rainy day ☔. Now, I’m not talking about money to be splurged on a big purchase. This money is to be used in emergency situations only (think losing a job and needing to pay those bills type situations). Usually, the preferred amount is anywhere between 3–6 months of living expenses, depending on your risk tolerance. If you feel like you could find a new job relatively quickly, just aim for 3 months initially. If, however, your occupation is not as in-demand as you’d like, it may be more prudent to bump that number closer to 6 months. Typically, I like to put this money in something like a High-Yield Savings Account, as the interest you receive from these is typically much higher than a traditional savings account. But, if you feel more comfortable or have a bank that you enjoy, by all means stick with them instead.
An IRA is a very interesting platform for saving and investing, and is something I personally enjoy exploring. There are a number of differing opinions on the strategies involved when investing in an IRA (and 401ks for that matter), including what type of IRA you should have (Roth vs Traditional). I believe that discussion to be out of scope for this post, but I will leave you with an article that goes more into depth around the pros and cons of each. For now, just know that as of 2019, the maximum contribution for an IRA is $6,000 ($7,000 if you’re over 50) and you should try and get as close to that number as possible. There are so many tax benefits when contributing to an IRA, that this should be your immediate choice over any other saving or investment vehicle. There are a lot of options when choosing an IRA, including the companies that offer them. My simple advice would be to go with a company like Vanguard and stick with a target date retirement plan. For instance, if you think you’re going to retire close to 2050 (~30 years from now), go with the Vanguard Target Retirement 2050 Fund (VFIFX).
Once you’ve reached that magic number and maxed out your IRA contribution, it’s time to dump a little more into your 401k. The maximum amount, as of 2019, an individual can contribute to a 401k is $19,000 (or $25,000 if you’re over 50 years old). When you begin researching your options for your company’s 401k, you might notice that your choices are pretty limited (quite a bit so, relative to your IRA). The best advice I can give here is to look through the details for each option for something called an expense ratio. The goal here is to get this number as low as possible and, ideally, it should be somewhere between 0.5% and 0.75%.
Brokerage or Taxable Accounts
If you’ve gotten this far with money left over and have maxed out both of the tax-advantaged accounts (401k and IRA) described above, your next option is to put that money in a taxable brokerage account. Technically, there are other ways to contribute more to a tax-advantaged account, including a Backdoor Roth IRA, but those advanced techniques are out of scope for this post. A brokerage account can be opened with the same institution you used to create your IRA above. The main difference here, is that any time your account generates income through dividends, you are taxed on that amount. You are also taxed anytime you sell your holdings on any gains it has made during that time period. These taxable gains could be either short-term, if you’ve held them for less than a year, or long-term (greater than a year). Short term capital gains are taxed at whatever tax bracket you currently fall under for that fiscal year. Long term capital gains are typically lower than short-term and can result in being taxed at 0%, 15%, or 20%, depending on your taxable income.
If all of this sounded a bit confusing or overwhelming, don’t worry, it was for me as well. There is a lot to digest and even more once you start digging into the different investment options in more detail. This guide was meant to be a high-level overview of the path someone could take to get their personal finances in order. As you move from one step to the next, it would be a good idea to begin reading more information about that topic, because the further down you get, the more advanced and complex each of these strategies can feel. I hope that I’ve provided you with a starting point, and a good general outline for planning your financial future. It’s my plan to write more in-depth topics about the strategies discussed above, and more, so I hope you continue coming back to read! 😄