Not sure whether to save, pay off debt, or invest for retirement? Use this 5-step guide to make smart money decisions. It will help you leverage your financial resources, reduce stress, and build wealth as quickly as possible.
Step #4: Fund your retirement.
After you’ve prepared for the unexpected with savings and insurance and dealt with any dangerous debts, it’s time to turn your attention to retirement. As I previously mentioned, this is a higher priority than paying off any low-rate debt, such as mortgages and student loans, ahead of schedule.
After you stop working you could, and hopefully will, live for decades. Whether you’ll live in poverty or have financial freedom in the future is completely up to you. Social Security benefits for the average retiree are only around $1,000 per month. That’s nice to have but isn’t enough to be comfortable.
The earlier you begin saving, the better. Not only does starting early give you more time to contribute money, but it leverages the power of compound growth. Compounding is when your earnings earn their own earnings! Your account balance can easily mushroom as the growth you receive provides even higher returns.
Consider this: If you invest $500 a month over 20 years for a 10% average return, you’d have about $380,000. If you started five years earlier and invested that same amount for the same return over 25 years, you’d have over $665,000.
But if you invested for 30 years, you’d end up with an impressive nest egg that’s over $1.1 million! Did you get that? Simply starting to invest 5 years earlier can give you an additional $435,000, even though you only put in $500 per month. Procrastinating even 10 years could make the difference between scraping by or have a comfortable lifestyle down the road.
A good rule of thumb is to never invest less than 10% to 15% of your gross income.
A good rule of thumb is to never invest less than 10% to 15% of your gross income. For instance, if you earn a $50,000 salary, be sure to invest from $5,000 to $7,500 per year. As I mentioned, if you do that consistently over several decades, you can easily retire with a million dollars.
If you have a retirement plan at work, such as a 401k, 403b, or 457, that’s the first place your savings should go. For 2019, the contribution limit is going up slightly from $18,500 to $19,000. And if you’re age 50 or older the limit increases from $24,500 to $25,000.
But what if you don’t have a job with a retirement plan? In that case, you can use a traditional IRA, a Roth IRA, or a special account if you’re self-employed, that also come with nice tax advantages.
The maximum amount you can contribute to an IRA isn’t as high as a workplace plan, but it’s likely to increase in future years. For 2019, you can contribute up to $6,000 or $7,000 if you’re age 50 or older.
Once you’re consistently saving 10% to 15% of your income for retirement, then it’s time to consider paying off your less expensive, low-rate debt ahead of schedule.
For a summary of different retirement accounts and their rules, download the free, one-page Retirement Account Comparison Chart PDF.
Step #5: Fund your goals.
The final step in making smart money decisions is to consider your other goals. Maybe you’ve got your heart set on buying a home, sending kids to college, starting a business, or paying off low-interest debts early.
Expenses you plan to make in a few years, such as buying a car or taking a vacation, should be saved, not invested. You’re better off protecting this money from market volatility and potential loss by keeping it in a bank savings account.
For dreams that you want to achieve beyond five years, use a taxable brokerage account for higher rates of return. Regular investment accounts don’t come with any tax advantages, but unlike a retirement account, you can take withdrawals at any time without penalty.
Making smart money decisions comes down to preparing for the unexpected by having financial safety nets. Then you’re in a great position to dig out of any dangerous debts, invest for the future, and save for any other financial dreams you may have.
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