If you’ve read my book Building Wealth And Being Happy: A Practical Guide To Financial Independence, you may remember that I had to cut some of the images out because of formatting issues. I promised to include supplemental info, and now I am! Here’s a flowchart that will help you prioritize your savings if you’re American. If you’re Canadian, click here.
- Emergency fund. Keep 3-6 months worth of expenses in a high interest savings account for things like major car, home, or dental repairs. At a certain point, say once you also have 3-6 months worth of expenses in your investment accounts, you may not see the need for an e-fund anymore. You can use credit cards and lines of credit in the event of an emergency. It only takes a couple of days to sell and transfer assets from your brokerage’s taxable account to you chequing account. Your comfort level with an emergency fund is totally personal and there’s nothing wrong with having a large one – but if it’s more than 6 months’ worth of expenses you’re missing out on investment returns that money could be earning for you.
- Employer plan to match. Contribute to your 401(k) (or 403(b) or 457(b)) to take advantage of the full match offered by your employer. The match is an instant 100% return!
- Debt. Paying off debt is amazing because it is a guaranteed return. It’s one of the only free lunches you can find in the world of investing! Make sure to read the earlier sub-chapter on Stomping out the debt monster.
- Health Savings Account (HSA). Contribute to a HSA if you’re eligible for one (I.e. your health insurance is a qualified high deductible health plan). Because you have a high deductible, you want to be ready to cover costs in the case of a medical emergency.,
- Individual Retirement Account (IRA). Contribute to an IRA if you’re eligible to. A traditional IRA is the better option if you expect your future tax bracket in the withdrawal stage to be a lower one than your tax bracket in the accumulation stage. In most other situations, Roth IRAs are the better option. We discussed whether or not you’re eligible for a Roth IRA in the chapter on Asset Allocation: Picking the right portfolio.
- Remainder of Employer Plan. Contribute the rest of what you can to your workplace plan. Whether it’s a traditional or Roth plan will again depend on your earning and spending situation.
- Taxable accounts. Contribute anything that doesn’t fit in any of the above containers to a normal, taxable investing account that you can open at any one of the big banks or popular discount brokerages.