Ever since the early Mesopotamian civilization, someone has asked someone else what to do with their money. Do they buy a new cow or do they buy a bigger hut? Search any Q&A style website and you will find that one of the most viewed questions is a variation of the age-old “I’m 23 and I have $5,000. What should I do with my money?” question.
I would like to present a solution for everyone, from ages 1 to 99, with any amount of money. The following steps aren’t just for recent inheritance recipients or lottery winners, these are the steps anyone needs to take in order to create a financially sound lifestyle.
Here’s how you can get a start on your path to prosperity:
- Create an emergency money fund
- Pay off non-mortgage debts
- Save for retirement
- Pay off mortgage debt
- Start taxable investing
- Purchase experiences
- Buy toys
Starting Your Emergency Money Fund
When it comes to life the only guarantee we have is that nothing is guaranteed. The unexpected occurs daily. Whether it’s a car repair, loss of a job, or emergency room visit, life happens. Your emergency money fund is your best defense against those life-ruining moments and should be the first step to saving money so you can limit the number of unexpected financial hardships.
Your emergency fund should contain at least six months worth of your living expenses. For example, if you spend $2,000 on food, rent, utilities, and commuting, you would need at least $12,000 in an emergency fund. If you have some extra money or if you are an extreme worrier, put away closer to 8-10 months of your living expenses into the emergency fund.
Paying Off Non-Mortgage Debt
Debt sucks. If I’ve said it once, I’ve said it 1000 times. Car payments blow. Credit cards entice you with free miles and fun rewards but kick your ass in interest payments. Student loans are used to pay for an overpriced education that lead to you working at Enterprise Rent-A-Car.
If you have extra money after funding your emergency fund, pay off your non-mortgage debts. You’ve already been given the product or lived the experience, it’s time you stop paying for it.
This is the second step for managing your money because, as a whole, Americans owe $882.6 billion in credit card debt. On a personal level, $1000 in credit card debt at 18% interest with a minimum payment of $25 will take you 113 months to be rid of your debt. In that time, you will pay $923.12 in interest. A trip to Vegas or a new wardrobe might be worth $1000, but is it worth $1,923.12? Probably not. Pay off your debts now.
Put Away Retirement Money
This is where you get to have a little bit of fun. The first two steps were all about preparing for or getting rid of bad stuff. This step is all about preparing for the fun stuff. Retirement is supposed to be a time where dreams become realities. Golf everyday, mimosas for breakfast on a Tuesday, living in beach house, and going on long exotic cruises. That’s the life.
Saving for retirement comes third because the sooner you start, the better your odds of making become. Due to compounding interest and proper investing techniques, anyone can reach retirement if they start early enough.
However due to a horrible level of financial illiteracy in America, only a limited number of retirees are actually able live this lifestyle. That doesn’t mean you can’t; it just won’t happen as easily as everyone expects it to.
In the past, companies offered pension programs. Pensions paid you a set percentage of your past salary when you retire. These don’t exist anymore; Social Security is starting to go belly up. Now, your retirement is fueled by personal savings via IRAs or 401(k)s. This means it’s no longer your employer or your government’s job to get your to retirement: it’s your job.
So, how do you get your money set up for retirement?
First, you need to find out how much money you need to have in retirement. Then, you need to find out how much you need to save to get there, and lastly you need to decide how much risk you are willing to take to get there.
Paying Off Mortgage Debt
Everyone needs a home. However, a lot of people don’t think they can afford to own one. A great path to homeownership is through the tried and true tradition of buying a small house, paying off the loan, selling, and then moving into a bigger house. Rinse and repeat until you are in your dream home.
If you don’t currently own a house, then view this step as the “saving for a down payment” step. If you currently own your house, view this step as the “pay off all your mortgage debt” step.
Either way, the fourth step’s goal is to get you into your dream house over the course of a few years (or, if you received a large lump sum, immediately). A house is important, but don’t over extend yourself. Buy something in your price range with a monthly mortgage payment you can afford.
Making Smarter Investments with your Money
There are a few things you can never have too much of: ice cream, tropical islands, and great investments.
You can invest your money for any reason. Early retirement, next home, new car, vacation, or just to see six zeros behind the first digit in your bank account.
There are a few things you need to know before you start investing, so do your research! Make an appointment with a financial advisor and take a look at how your 401k is invested. Consider how aggressive you want your investsments to be versus when you’re looking to use that money (retirement? College for future kids? Starting a business?).
Investing is your fifth step due to the fact it is so versatile. Investing helps to grow your money without you doing anything except sitting back and letting the market work for you.
Experience Your Money in Action
Studies have shown that even though humans greatly envy their neighbor’s material possessions, they actually enjoy their own experiences more. Everyone wants the new car, the new suit, the new home, or anything their neighbor has that is better than theirs. When it comes to a dollar-for-dollar comparison, people enjoy experiences more than possessions.
If you’ve done the first five steps and still have extra money laying around, take a vacation. I’ve been told the Maldives are beautiful this time of year….or anytime of year.
Buy Yourself Some Toys
If you have an all-star and fully-funded emergency fund, have paid off all your debts, are on your way to easy retirement, have paid off your home, have invested for the future, and have explored the world, then it’s time to buy some toys.
A limited amount of people actually deserve to have toys. If you’ve accomplished the previous six steps, you deserve a toy. Buy an exotic car. Buy a plane. Buy whatever you want in the world.
The next time you get a gift, tax refund, inheritance, or lottery winnings, just go through these steps. Unless you are the Powerball winner, you won’t be able to blow through all the steps in a single year (or possibly decade).
Over time, you’ll be able to accomplish all of your goals if you manage your money smart. No matter how much or how little money you have, it can go towards one of these steps. No matter what age you are, you can start your path to prosperity.