How should those precious savings be allocated?The specifics will vary based on individual situations, but there are a few high-impact decisions that can go a long way in securing your financial future.
Build up an emergency fundNow that you understand the dollar cost of your basic necessities, it’s helpful to start building some runway in the event an emergency occurs (loss of job, medical surprise, or family commitment).
A good rule of thumb is 6 months of basic living expenses (vacations get cut out of this calculation), but this can vary based on your number of dependents, your partner’s financial situation, and whether you could go back to living with a family member.
Get that 401(k) matchNext, check to see if your company offers 401(k) matching — it’s basically free money (for your retirement).
Employers on average match 2.
7% of an employee’s paycheck, and that money will then compound (in a tax-efficient manner) for multiple decades.
Consider paying down high-interest rate debtOnce you’ve collected the “free money,” look for instances where you’re paying it away in the form of high-interest debt.
The likely culprit is credit card debt, but this can include other types of personal loans (umm, that new TV) or even payday lending.
Depending on the interest rates, private student loans could also qualify.
When it comes to paying down debt, there isn’t a specific interest rate threshold to determine which debt to pay (i.
e.
pay off debt that’s > 5%).
That’s because debt is impacted by its tax deductibility status (i.
e.
mortgages and federal student loans), your tax rate (both Federal and State), and your investment alternatives (i.
e.
opportunity cost).
But remember, it’s hard to go wrong paying down debt — especially the kind with high interest rates.
Step 4: Identify your long-term savings goalsYour options multiply tremendously when you make it into this last phase of the waterfall.
Here it helps to take stock of your long-term goals such as buying a home, saving for your kids’ college, an epic vacation, helping out family members, getting a head start on your retirement, or all of the above.
Morningstar offers a Master List to help you start identifying these goals, which include:Now don’t beat yourself up if the number of goals feels overwhelming, or if you can’t see how your current income could ever get you to a specific objective.
Investing is a long game and like Einstein said, “Compound interest is the 8th wonder of the world.
”You’re on the path to masteryWith these simple steps, you’ve easily crossed the Pareto Principle of sound financial planning.
And thanks to the power of these apps and the ability to automate saving and investment decisions, you’ve already unleashed your personal compounding engine that can be maintained in less time than it took to read this post.
And herein lies the best part of budgeting: it frees up both time and mind space, enabling you to spend time on the activities you love and the people you care about most.
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