Here is the situation… You just received a bonus from work. What do you do with it?
Buy yourself the newest iPhone?
Leave it in the bank?
From top to bottom, here is how you should prioritize your inflow of capital:
Always have an emergency fund. Ideally, a savings account that you cannot easily access. I recommend keeping 4-6 months of essential monthly spending saved away. Treat this as a safety net, used only for emergencies. This should be out-of-sight, out-of-mind to prevent you from dipping into the funds.
2) Bad Debt
Bad debt refers to financing tied to purchases that lose value over time, much like car loans or credit card debt. You are essentially borrowing money to purchase depreciating assets which should be avoided as much as possible. Any loan that simply carries a high-interest rate would be considered bad debt as well, no matter the purpose. If you have bad debt, always look to chip away at these balances because it is unlikely you will return your original cost.
Invest in your career. This is arguably the most significant driver toward creating wealth, whether in your current job or if planning to start a business.
4) Stock Market Investing
While you could increase your contributions to your retirement plan at work, this refers to investing beyond your 401(k). Add funds to a brokerage account or make an IRA contribution. Not only does this help you diversify, but a brokerage account provides greater liquidity than a 401(k) does. As you invest, construct a plan that focuses on what you need to earn each year to meet your future needs and goals.
5) Primary Real Estate
Acquiring cash does not necessarily give you the green light to purchase a home. Know the time constraints, mortgage payments, and tax implications associated with owning a home. If planned out well though, buying a home can be a great way to diversify your wealth. It also allows you to stop paying someone else’s mortgage as a renter.
6) Childcare/College Savings
Boost your savings for your kids. Daycare is expensive. College is as well, but tuition costs vary dramatically, so develop a specific savings goal, plan it out, and execute. Utilize tax-advantaged vehicles to help along the way. I recommend a 529 College Savings Plan mainly because anyone can participate and the earnings grow tax-free if the funds are eventually used for qualified education expenses.
7) Good Debt
Some debt is productive in the sense that you are financing something that increases in value over time. For instance, a mortgage or business loan. These debts carry a lower payoff priority but remain viable options because the smaller the debt balance, the less interest being paid.
8) Hard Assets
Last but not least, use your extra cash toward hard assets like a car or boat. If you reach this stage because you have adequately covered all of the preceding steps, it is okay to splurge.
If you would like some guidance on how to prioritize these steps around your situation, please contact me directly.
Joshua J. Baird
Investment Adviser Representative