Top 5 places to put your money TODAY

This is NOT the place for your hard-earned dollars!

Where should you put your money?  There are a ton choices including credit card debt, retirement accounts, mortgage payments, that new Le Creuset stockpot that you’ve always wanted, a trip to Tahiti, etc.  Below is a list of where I think most people should put their money in order of priority.  That means that I recommend maxing out the first item on the list before going down to the others.

This list assumes a couple of things:

1) You have some cash to put towards these things.  If you don’t, you need to read Rule #1 of personal finance, cut costs where you can, optimize your spending, and automate your savings.

2) You are not endangering your health, have proper levels of insurance, and aren’t making yourself miserable by living like a total pauper because you’re following my savings suggestions to the extreme.

3) You’ll tailor this order to your own personal situation.  (But even so, I strongly recommend following items 1 & 2 in that exact order.)

Okay, ready?  Numero Uno for where your money should go is….

1) Employer 401k matching

If you’ve read my articles on retirement, you’ve heard me say this before: don’t leave free money on the table!  What type of return do you  historically get from a risk-free investment?  Treasury bonds have returned about 4-5% annually.  What is your employer match return?  If you get matching of 50 cents on the dollar up to 6% of your salary, your return on that first 6% saved is an instantaneous, huge, risk-free 50%!!! There’s no better investment in the world that I’m aware of.  Max this out no matter what!

2) High-interest debt, like a credit card

– Some readers might quibble with this as #2, I can hear them now: “What!? Paying off your credit card balance is always the first thing you should do!”  There may be emotional benefits to making this #1 that you should consider, but  if your employer matching is 50% instantly, and your credit card rate is 25% annually, you’ll do way better to first max out your 401k matching.  After that, put the rest of your cash towards that VISA balance.

(Of course, if you have a rate as outrageous as this one, you may want to switch to paying this off first…)

3) Emergency fund (3 – 6 months worth of living expenses)

You need to have some money socked away for unforeseen expenses or losses of income.  While you should at least have long-term disability insurance to protect yourself against injury, you also need a shorter-term stash of cash to tide you over if you lose a job, get sick, or have to replace something valuable, like a car.  The general rule for insurance is to insure things which you wouldn’t be able to replace relatively quickly and that would cause you hardship if you had to go without them.  This includes your home, life, health, and possibly your car or jewelry, depending on the retail value of these items and your personal savings.  (Make sure to avoid useless insurance.)

Expenses you can afford should be ‘self-insured’ by your emergency fund or other savings.  Raising insurance deductibles and banking (NOT spending) the difference in premiums is a good way to self-insure against small losses ranging from a few hundred to a few thousand dollars.  Store emergency money for unexpected car repairs, insurance deductibles (which can be large if you have catastrophic health insurance like I do), or high vet bills for your disgustingly-cute Cavalier King Charles spaniel.

Whether you need more or less living expenses saved depends on how steady your income is & how many liquid assets you already have (like non-retirement stocks that you could tap.)  The more financially secure you already are, the less of an emergency fund you need: a self-employed person with few liquid assets needs more emergency funds than a union schoolteacher with 20 years seniority and a sizable investment account.

Like all short-term (less than 3-5 year) savings, your emergency fund should be investing in something that is not only stable and liquid (easily accessible), but that will also give you a decent return on your investment.  High-interest savings accounts like the kind from INGDirect* fit the bill for very short-term savings since the principal is guaranteed by the FDIC.  Bond funds, which may vary slightly in principle but generally yield a higher return than savings accounts or CDs, work better for money that might sit there awhile.  I use a low-fee, highly-diversified bond index fund for my emergency fund due to the higher returns compared to high-interest savings accounts.

(Read this for an advanced way to juice your emergency fund interest rate while keeping your principal safe & accessible.)

4) Tax-advantaged retirement accounts (401ks, Roth or Traditional IRAs)

After you’ve maxed out your employer retirement matching, paid off your debts (except perhaps your lower-interest mortgage or student loan), and stored money for emergencies, it’s time to go back to saving for your retirement.  Read up on the Roth IRA, and then read this to see if it would be better for you to put your retirement savings in a pre-tax account like a 401k or an after-tax account like a Roth IRA or Roth 401k.  For people in high-ish tax brackets (25% and above as a rule of thumb) and who don’t already have a large pre-tax dollar nest egg saved up, I recommend putting the bulk of your retirement savings into a 401k plan (or a Traditional IRA if your employer doesn’t offer a 401k.)

If retirement is still 5-10+ years off, invest in broad, low-fee stock-market index funds like those that track the S&P 500 or the total stock market.  Index funds outperform mutual funds about 70-80% of the time and require no maintenance on your part since they passively track the entire market for you!  Any good 401k plan should offer at least one of these indexes.  If you’re investing in a Roth or Traditional IRA, select a mutual fund company that offers a good selection of  low-fee index funds like Vanguard or Fidelity.

Putting money into a tax-free retirement vehicle is critical to building up a nest egg for the future.  Assuming you’re in the 25% tax bracket (and some other things**), an investment in a tax-advantaged retirement account made when you’re 25 will be worth about 55% MORE in real dollars when you’re 65 than would an equivalent investment in a taxable account.  (Obviously, if your tax bracket is higher, it’s even more advantageous to avoid taxes.)

5) ‘Regular’ taxable investment accounts & short-term savings for big purchases

After you’ve either maxed out your retirement options (you’re a beast!) or decided you’re contributing enough to retire how you want to at a given age, it’s time to look at plain ol’ taxable investment accounts for long-term savings.  (Index fund recommendations still apply.)  I like to think of these as early retirement accounts; the more you sock away now, the quicker you can exit the rat race (or do something for lower pay that you like more.)

Also, you should be saving regularly for big purchases like a house, wedding, vacation or new car.  For these short-term items, I use the high-interest savings sub-account technique that I learned from Ramit Sethi (you could also use the Roth IRA ‘hack’ I mentioned in priority 3 above.)

Simply open an ING high-interest savings account*, then create multiple savings accounts, labeled according to each item you’re saving for (‘Wedding’, ‘San Francisco trip’, etc.)  Then, set up an automatic monthly contribution to each account based on the amount of time you have to save and the amount of money you’ll need.  For example, if you need $30,000 to put down on a house in 2 years, that’s $1250 per month that you need to be saving ($30,000/24 months = $1250 per month.)

Note that you might sometimes rank some short-term savings goals as higher priority than maxing out your retirement accounts (#4.)  That’s fine, but do NOT neglect your retirement.  Investing early, even with just a little bit of money, is the most important factor to building wealth.  Saving for retirement will be way easier if you start today with whatever you can.

Conclusion

So there you have it, the rank-ordered top 5 places to put your money: 1) Max out employer matching contributions before anything else, 2) pay off high-interest debt like credit cards, 3) create an emergency fund of 3-6 months worth of expenses, 4) put as much as you can into tax-advantaged retirement accounts, and 5) bankroll anything left into short- & long-term (taxable) savings/investment accounts.

Take each step one at a time until you’ve successfully mastered it, then move on to the next one (don’t try to do it all at once!)  Once you’re eventually able to do all of these things, consider yourself pwning your money!

Now that you know where to put your money, find out WHAT to invest it in here.

[And just for good measure, here’s a link from the Motley Fool’s insurance page, which should contain some complimentary info to this post.]

* If you want to set up an ING Direct high-interest savings account, the first 24 people that email me can get a referral link that will get them a $25 bonus if they deposit at least $250 when setting up the account (I’ll get a $10. referral bonus.)

** This assumes dividends & capital gains remain at the historically low rate of 15% for those in the 25% and up brackets.  It also assumes an effective tax rate at retirement of 16%, which corresponds to an income in today’s dollars of about $90K for a married couple.  If dividend or capital gains rates go up, tax-advantaged accounts perform even better against taxable accounts.  On the other hand, if your tax rate goes up relative to the capital gains rate after you’ve retired, tax-advantaged accounts lose some of their edge (but they’re always better.)

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12 Responses to “Top 5 places to put your money TODAY”

  1. Dave Watson Says:

    And Low-interest debt like mortgages? I have trouble deciding between paying the mortgage off faster, or investing in more index funds.

  2. Ward Williams Says:

    Dave – Short answer: If you’re not yet maxing out tax-advantaged accounts, then I would definitely say invest more in those first. Even if you ARE maxing those out, then I would lean towards funding your taxable stock accounts, assuming your mortgage rate is lower than ~7% or so.

    Here’s why (long answer):

    Historical market returns are ~10%, and if you buy and hold for a long time, the taxes on those returns become fairly minor (we’ll say ~15% maybe, given taxes on dividends & long-term capital gains.) 15% would reduce your after-tax return to 8.5%, still likely better than your mortgage. Plus, your effective mortgage rate is likely lower based on tax deductions:

    If your mortage rate is 6% and you’re in the 25% bracket (and still much more in mortgage interest than your standard deduction), the effective interest is probably around 5%. (The reason it’s not really 25% less (4.5%) is because without itemizing you would still use the standard deduction. The benefit only applies to mortgage interest over the standard deduction.)

    Of course, there’s also some psychological satisfaction to owning your home outright, so you should consider that as well (but I would still definitely max out retirement accounts first due to the tax advantages.)

    Hope that helps!

    • Ward Williams Says:

      I should add that once you take off 3% inflation, the higher effective rates for stock investing (~5.5-6% real return) vs your mortgage (maybe ~3% real return) make it clearer that stocks are probably the better way to go. However, stock investing in the short- to medium- term (<5-10 years) is more volatile than the guaranteed 'return' of paying your mortgage. This is more reason to buy stocks intended to hold them for a long long time.

  3. Intro to Investing (asset allocation, stocks, bonds and more!) « Words of Ward: Ward's Guide to Personal Finance and Investing Says:

    […] stocks, bonds and more!) January 10, 2010 — Ward Williams After understanding where you should put your money, you need to know WHAT to put it in.  The ‘what’ question is first one of ‘asset […]

  4. Greg U. Says:

    Ward,

    Before you judge what I am about to write please realize this is only me and we all have our opinions. But I freaked out about 2 things and saving money helps one thing but does not help the other, let me explain. The two things that freak me out is.

    1. The giant earthquake that is supposed to hit the westcoast within the next 50 years.

    2. An attack or some sort of communication by “aliens” or some other form of life.

    In talking about number 1 saving money is good because if an earthquake happens then you will have money saved up to replace your stuff so I don’t need to go into this. But what I am trying to say is people have there retirement fund, there emergency funds, I know this goes under emergency but maybe there should be an earthquake fund. I do hope though, that we get more help than Haiti because the Westcoast can contribute to society more than they can.

    In talking about number 2 I really think people (or at least I am) should put aside money in case of an alien attack. I am not kidding, I am huge believer of “aliens” and UFO’s. Ward you know this about me and even though the chances are slim, I think that there is the chance that we get attacked by aliens. Not because the aliens want to purposely be mean to us, but because we have resources they may want (metals and such), we might be a food source, their planet’s resources may be gone and they need to infest somewhere else. There could be a lot of reasons. The article or theory by Steven Hawking didn’t help either where he thinks that it’s perfectly rational to think that with how big the universe is that there is more life out there. I for one am a believer, as the X-files says at the end of the shows intro “I want to believe”. I feel the government messed up and there’s too much information out there, there’s an area 52 in Utah now that has an alien spacecraft stored underground. Area 51 has an alien body or bodies and material from the crash from Roswell Mexico. Aliens are real and they might not be nice. I agree with Hawking that we should have some sort of plan or attack and I for one will not be caught off guard. I think you and everyone else should plan accordingly just in case as well. If you save enough money you can use it to build a shelter or to buy supplies or something! You can also use these supplies for the earthquake! If they don’t attack then you have extra money! You just have to spend that money where you tell yourself that you don’t mind dying if they attack.

  5. Stubbings Says:

    This employer 401k matching… I’ve never heard of it. Do most employers generally do it? Should I just speak to my boss about it? It seems like an obvious choice to invest in but I’m not sure that mny employers offer this….

    • Ward Williams Says:

      @ Stubbings – Re: employer 401k matching: I’m not sure how widespread employer matching is, but most of the folks in know in private sector white collar jobs (like engineering, paralegals) have it.

      You can ask your human resources folks to see if it’s available to you or other employees at your firm (it may not be for you, but if it is, definitely max it out.)

  6. Stubbings Says:

    Also… wht would you sy the best way to invest $20,000 would be, short or long term? Index funds seem great but I feel like I would want to keep it all together in one lumped, invested, sum….

    • Ward Williams Says:

      @ Stubbings: RE: investing $20 K: Your question can’t be answered fully without more context. I find that the best way to think of how to invest is by first deciding what your financial goals are. I recommend deciding what area of your life could use that $20 K investment. Assuming your credit card debt is paid off, you might want to 1) put money aside for retirement (depending on your age, this might mean mostly in a stock index fund for the long-term) or 2) buy a house (likely a bond index fund for the short-term) or 3) some other goal.

      In each of these cases, the appropriate investment depends on how far away your goal is. I use the rule of thumb that any money I need in the next 5 years should be in a stable bond index fund (or in cash if 5 yr) goals like retirement or Vanguard’s VBMFX (total US bond fund) for short-term (less than 5 yr) goals like buying a house.

      Hope that helps!

  7. ratnakar Says:

    can u send me some more information about how to invest money.


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