Personal Finance Priotiziation

How should we manage our money?  Do we have a plan?  As we leave school and enter the workforce, we accumulate a little more wealth and are buffeted with all sorts of financial decisions.  Have a plan!  I sure wish I did when I was younger!

Typically, new white collar workers out of college join a company and are asked all sorts of questions related to how to invest their money beyond just getting a pay check deposited into their checking account.  These questions are related to retirement as well as health care.  As we get older and have children, we have to consider saving for their college tuitions.  What to do?

In [2], Tae Kim recommends the following order of money allocation

1.  Emergency fund - This is a no-brainer.  First create a budget (I never did, but wish I did) and then figure out how much you need to live for 3 to 6 months.  This is how long it may take you to find a new job or adapt your expenses in the event of a sudden life change.  Yes, younger people may not fully know what being independent and fully responsible for expenses is like, but as you get older, the likelihood that you will need to dip into an emergency fund increases.

2.  401K match - Employers often match your 401K retirement plan contributions by X percent (often 50%) for Y percent of your annual salary (Y is usually in the low single digits).  If you make $60,000 annually, your employer might match your first 6% * 60,000 = $3,600 in contributions by 50%, or $1,800.  This is "free money," so many people recommend taking advantage of it.

3.  High interest debt - Putting this item in position 3 instead of 2 in questionable.  Credit card debt can have interest rates of over 20% annually, so it is important to get rid of this debt quickly or it can grow out of control.  I believe the reason Tae Kim listed this important expense at #3 instead of #2 is that saving 20% off of some balance is not as advantageous as making 50% off that same balance with a 401K.  Of course, even if you have a 401K with such a match, you won't be able to access that money until you retire, so, do the math and do what's best for you.  If your company does not offer a 401K match, this is a moot point:  pay off your high interest debts.

4.  Roth IRA - A Roth IRA allows you to put post-tax money into an IRA account and have it grow tax free and have tax free withdrawals.  (See if you can contribute to both a 401K and an IRA.)  If you are already maxing out your 401K contribution and have money left over, you can still make contributions at a Roth IRA depending on your income.  If you make too much income to contribute to an IRA conventionally, you can still contribute through a backdoor Roth.

5.  HSA - I may put this in position 3.  An HSA - health savings account - is a savings plan you qualify for if you choose a high deductible health plan (HDHP).  With such a health plan, you have a high deductible, lower premiums (maybe about 10% lower), and can put money into an HSA.  Money put into an HSA is restricted to health expenses.  However, HSA money is "triple tax advantaged."  You put pre-tax money into it, growth on it is not taxed, and, withdrawals for health expenses are not taxed.  Another nice option is an HSA can be started in a brokerage account (e.g., Fidelity's HSA).  You can trade the money in an HSA as with any brokerage account.

I may rank HSAs higher because, although the use for this money is restricted to health expenses, you do save on premiums and taxes.  If you are a healthy person, who seldom goes to the doctor, it's like free money.  Even if you are older and have kids, saving in an HSA for a time when you really need money (e.g., when you retire) make sense.

6.  529 - A 529 is a savings account for education (e.g., tuition and books).  Some contributions can be deducted from taxes in some states, but they are not deductible from federal income taxes.  Growth in these accounts are not taxed federally or at the state level.  If you apply for financial aid for your child, 529 savings have some advantages over other types of savings.  Ultimately, because of the lack of a federal tax deduction and the limited investing options you have with a 529, I'm not certain how beneficial a 529 is compared with other investments.

7.  Maximize 401K - 401K growth is not taxed, which makes it attractive.  

8.  Taxable account investing - After taking advantage of tax advantages, then you can invest in the market.  In the tax advantaged accounts above, you are guaranteeing a savings of, say, at least 25% in growth, if you save on federal taxes.  It would be hard to beat that on your own by investing in a taxable account.  You also have to deal with market volatility if you choose to start investing in the market.  How to invest this money is another topic!

9.  Lower interest debt - Lower interest debt is defined by Tae Kim as debt with interest rates below 5%.  It makes sense to deprioritize compared with all the above because we assume that you can make more with the items 1-8 than you spend on low interest debt.  For example, historic growth on the S&P 500 is over 10%.

10.  Mortgage - Finally, if you want to get rid of your mortgage, you can, for psychological safety if nothing else.  However, mortgage interest is tax deductible and, if you got a mortgage before recently (early 2022), your mortgage probably has a low interest rate of 2%-5%.  I agree that keeping a mortgage makes sense.

Ultimately, when thinking about where to invest any cash, consider the following:

• Do I need money now or later?  If I'm tight on cash, then I may go for investments with federal tax advantages (e.g., 401K).  Otherwise, I may pay now with a Roth IRA.
• Do I care about how I can invest the money?  HSAs and Roths allow you to invest money as you see fit, but 529s do not.
• Do I care how I spend the money?  529s are restricted to educational expenses and HSA are restricted to health expenses.  Are these reasonable restrictions?  If I want unrestricted payouts later, Roth IRAs are the way to go.

In general, I liked the video and liked how Tae Kim listed all the conventional investment options offered to people and gave some straightforward reasoning on why one should be prioritized over another.  How you actually invest should be based on your own circumstances, but his video is a good conversation starter.