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You get paid and before you know it, you have no idea where your money has gone. Below I’ve outlined some recommendations on how to allocate your paycheck to maximize your wealth building opportunities. Please note that everyone’s situation is different so these items below serve as recommendations only and should be tailored to fit your specific budgetary needs and goals.
Before you start depositing money into investment or retirement funds, you have to satisfy your basic needs. Set aside the money you need every month for basic living expenses which include rent, utilities, groceries, gas, car payments, etc. Maxing out your 401k will do you no good if you have no place to live or food to eat.
Life happens and with that comes car trouble, lay-offs, or just unexpected costs. If you don’t already have 3-6 months of living expenses built up, I suggest you deposit money each month into your account until you get there. Saving money is made even easier now as companies will allow you to allocate a % or absolute dollar amount of your paycheck to be automatically deposited into a separate savings account so you don’t even have to think about it. Even better, you can now take advantage of high-yield savings accounts that will yield interest rates up to 5x higher than the national average. CIT Bank has a great savings account offer. Click here to sign up today.
Now this step is quite controversial. Financial guru Dave Ramsey, with his no-nonsense approach to finances, will tell you to pay your debts from smallest to largest before engaging in any sort of investments (excluding your home mortgage). I agree with this sentiment under four conditions:
1) The cost of your debt (through the interest) exceeds any potential gains you may make in investments.
2)The debt is relatively minimal and can be paid off in less than a year (losing a year of investing is not a big deal if it means you’ll end up debt-free).
3) Maintaining this debt is stopping you from reaching other major goals. For example, if you are looking to buy a house and are sitting on a considerable amount of debt that is taking you above and beyond the desired debt to income ratio. You don’t want the debt stopping you from achieving your goals.
4) You’re not good with budgeting. This last one is a little tricky because you have to really know yourself and make an honest assessment. If you have a hard time sticking to your budget, focusing on your debt first is a good idea (in my opinion) as it allows you to be dedicated to a single financial goal vs. trying to juggle a whole portfolio.
However, if you feel you can manage the monthly cost of the debt alongside your other living expenses, and the interest rate does not exceed other potential gains, then I don’t see anything wrong with paying this as you go. I do however, advise you to set a debt repayment goal. There are plenty of free tools online that will help you calculate your pay-off based on monthly contribution and interest rate. If you can pay more than the minimum towards the principal balance, even better.
Assuming you can cover all your basic living expenses and have enough saved up for an emergency fund, I recommend allocating at least 5-10% to your salary to your company’s 401k. 401ks are a great retirement tool that and with an automatic deposit, you won’t even miss that money. Starting in 2022, you can contribute a max of $20,500 each year. If you don’t have a 401k or you are able to contribute a little more to retirement, I recommend a Roth or Traditional IRA (which you qualify for will depend on your income). Roth and Traditional IRAs both max out at $6,000 each year ($7,000 if your’e 50+). At the end of the day, whether it be through a 401k or an IRA, I recommend contributing at least 10-15% of your income every month to a retirement plan.
I’ve lumped these into one group as how you allocate funds will depend on your situation and financial goals. If you have children you will likely want to contribute to a college savings funds. Or you may want to contribute to a short-term savings goal such as purchasing a home or buying a car. Having trouble getting started on saving? Try a money saving challenge to help get you motivated and builder better habits.
Now that you’ve covered living expenses, emergency funds, and retirement, we can move onto investment funds. Investments can be stocks, ETFs, mutual funds, or any other investment tool. If you’re new to stocks you can check out our article on how to get started. How much you contribute every month will depend on your two things:
1) Your level of emotional comfort or risk tolerance.
2) Your financial ability (how much you have left over/are willing to spend).
After what may seem like forever, you’re finally ready for that fun money. These are the “wants” in your life. This is shopping, travel, and anything that is not a basic necessity to your everyday life. This is also a great time to be generous. Leave that 30% tip or donate to your church or favorite charity.