Every few weeks or so I notice on many money forums someone will inevitably ask the question: What should I do with my savings? Or “I have $10,000 in my savings. What should I do with it?”
First off, to have anything saved up in this live rich, spend fast world is actually great! So go ahead and give yourself a pat on the back.
Just once though because you’ve got a lot farther to go before you can consider yourself financially fit.
Naturally, there are plenty of things you can do with your savings. It’s just that all of them might not be a good fit for you. And of course, you wouldn't want to do anything that could cause you to lose the money that you have worked so hard to save.
You have a good foundation so far, and now is the time to make it grow. And I’m here to show you how.
The first thing you should do with your savings is to establish an emergency fund. Then max out your HSA, followed by your Roth IRA, and finally, depending on the options available to you, max out your 401k.
This is of course assuming that you:
1. Don’t already have an emergency fund.
2. Are NOT in debt. (not including your mortgage)
3. Have already contributed to your company’s 401k plan up to the employers match.
If you are still in debt and/or you have not already set up a 401k, we will talk more about what you should do below.
If you do already have an emergency fund of at least a few months bare minimum expenses, you can skip that step and move on the next.
Unless, of course, you are still dealing with the burden of debt. In which case, you need to stop everything and pay that off. By debt, I mean credit card and car debt.
Your mortgage can wait as the interest for mortgages are generally very low and you could earn more money by investing than paying it off.
What Should I Do If I Still Have Debt?
No matter how you slice it, debt will weigh you down and you must get rid of it if you are to become financially stable.
Even so, if you do not first have an emergency fund established, you might find yourself getting right back into debt every time your car breaks down or you stub your toe.
So the first thing you need to do is open a high yield savings account and put in $1000 for your emergency fund. This should be sufficient to cover most emergencies that may come up in the near future.
However, if this is not sufficient to cover your car and health insurance deductibles, you should definitely add more. As a rule of thumb, make sure your starter emergency fund can cover your deductibles!
Debt Payoff
After you set up your starter emergency fund, you can next focus on paying down your debt. Use your leftover savings to start paying it off.
If you have read my other posts, you would know that my suggestion is that you start paying on the debt that is burning the biggest hole in your wallet.
To determine this simply look at the interest rate or APR for your credit card or loan. The one that has the highest is the one that is costing you the most money. So start there and pay it off fast.
Throw any extra money you can scrape up at it. Trust me. Your wallet will thank you.
I am also a fan of the Snowball method as who wouldn't love that sense of joy and accomplishment that comes when you pay off a debt. The snowball method requires you to pay off the debt starting with the smallest.
Once that debt is paid off, you take all the money you were throwing at the first debt and put it to the second smallest debt. And so on until all of your debt is gone.
This method keeps you engaged in the debt pay off process by giving you quick wins. So if you think you will need that regular boost of confidence and inspiration, I recommend you do the snowball method.
As always pick the debt payoff method that is best for you. But no matter which method you chose, always make sure you are at least paying the minimum on all of your debt.
Should I Pay Off My Debt Before Investing?
If you find that you have extra money saved up and you could either pay down debt or invest it, do you know which to choose? Really the only things that matter in your decision are the interest rate of your debt and the rate of return for your investment.
If the interest rates or your loan is greater than the rate of return you can receive from investing it is better to pay off your debt as you return is automatically more.
The average rate of return for the stock market has historically been about 10%. If you subtract out inflation of about 3%, you get 7%. Thus, if your debt is costing you more than 7% in interest you should pay off your debt first.
So you don’t have to pay off all of your debt before you start investing - just the costly ones. And do it fast so that you can start having your money work for you.
I think most finance experts would agree. Time in the market is so important that no matter how small the amount, you should start investing as soon as possible.
* Note: The average return of 10% is the average historical rate and may not be the same in the future. Many financials experts have predicted that returns are going to be much lower in the coming decades maybe 5 or 6%.
But with the recent crash of the stock market due to the coronavirus, maybe that estimate too will change.
What Should I Do if I Haven’t Started a 401k?
If you haven’t started a 401k, what you’ll want to do is find out if your employer offers one and what the employer match is. Then you’ll want to invest as much as is necessary to get the employer match.
Some companies for example will match 100% of your contribution up to 6% of your salary.
So, for instance, if you are making $50,000 a year then your employer will match up to $3,000 for the year. This means you should plan to invest $3,000 as well to receive the match.
If, however, your employer only matches 50% of your contributions up to 6 percent of your salary you will have to put in $6,000 to get the whole $3,000 match.
Once you figure how much you will contribute each year to get the match, you are then going to take a look at your investment options.
You should invest in low cost total stock market index funds, total bond market index funds, and for some diversification total international stock market index funds.
If those are not available, then just do the best you can to keep costs low. Check the administrative fees and who pays them as well as the expense ratios for anything you want to add to your portfolio.
For me, an expense ratio of 0.5% is exorbitant and I would steer clear. Especially considering that some funds have expense ratios as low as 0.015%
Fees too high?
If you find the fees in your 401k to be too high, then you’ll want to forgo investing any more into it after getting the employer match and instead you should focus on maxing out your HSA (if you have one) and your Roth IRA.
And after that, you should invest in a taxable brokerage account.
If you don’t have a Roth IRA and your income isn’t above the limit, you should consider getting one as they usually have more investment options than a 401k and they provide you with more tax options in retirement, as withdrawals are tax-free.
To find out more about the various retirement accounts check out my article, The Complete Guide to Investment Options For Retirement.
What should I do if I have debt and no 401k?
If you have debt and have not started a 401k yet, then the order in which you should invest changes. First, you should check if your employer has a match program.
And if they do, your first priority should be to get the match because the return on your investment is automatically 100% or 50% (depending on how much your employer matches) way more then the return you will get from paying off debt.
So first get the match then follow the steps above for if you have debt.
If your employer does not have a match program, then pay off the debt first. Unless, as stated previously, the return on your investment will be greater than the cost of your debt.
Where Should I Open Up My HSA, Roth IRA, or Brokerage account?
There are so many options available, thanks to the advancement of technology, that you can find brokerages online and even through various apps. I haven’t tried most of them by a long shot but here are the top one’s I hear about most often:
I personally love Vanguard and Schwab but, from what I’ve seen, Fidelity has, probably, the lowest expense ratios around.
All in All
Having savings is comforting because at least you know you have money should anything happen. But there is such a thing as having too much savings. You don’t want your money rotting away in a bank losing its value every year due to inflation.
You need to have a plan that will make your money work for you and adequately prepare you for the future. If you have savings already, you are doing better than most. But now is the time to invest some of it. Go ahead take that leap. It will be worth it.
*DISCLAIMER: The Information provided in this post is simply the opinions of the blogger and is given in the spirit of educational fun. It is not investment advice. Please do your own research and decide what is right for you before investing in any asset. If necessary, seek the help of a certified professional in discussing your options.