If you remember back to your math or computer programming classes, you might remember the term “order of operations” even if you don’t recall precisely what it means. Here’s a quick refresher:
In mathematics and computer programming, the order of operations is a collection of rules that reflect conventions about which procedures to perform first in order to evaluate a given mathematical expression.
Investing has an order of operations too. If you want your money working optimally for you, it’s essential to follow the correct investing order of operations.
Establish an Emergency Fund
An emergency fund is an easily-accessible cash reserve meant to cover the cost of unexpected emergencies like a car or home repair or a medical expense.
An emergency fund is the foundation of your entire financial life; it shores things up when something hits the fan. An emergency fund will prevent you from taking on a credit card, personal loan, or, worst of all, payday loan debt.
How much should you have in your emergency fund? It depends on things like your level of risk aversion and the dependability of your income. But as we all saw during the pandemic, we can lose even the most secure job through no fault of our own. At least three months’ worth of necessary expenses; housing, groceries, auto payments, insurance premiums, etc.
Given recent events, 9-12 months is even better. If you don’t have an emergency fund or a small one, no one expects you to accumulate 9-12 months immediately, but it should definitely be one of the goals you work towards
.Where should you keep an emergency fund? Somewhere accessible but not too accessible, meaning not in your checking account. When your emergency fund is mingling around with the money in your checking account, it can be tempting to spend it. A high-yield savings account is a good spot to park that money. No savings accounts pay an interest rate worth writing home about, but some digital banks offer better rates than conventional brick and mortar banks.
Contribute Into a ROTH 401(k) up to the Employer Match Amount
A ROTH 401(k) is an employer-sponsored retirement investing account funded with post-tax money up to the plan’s contribution limit. For 2021, the limit is $19,500 and an additional $6,500 for those aged 50 or older. A ROTH 401(k) is best for those who expect to be in a higher tax bracket after retirement than during their working years because withdrawals after the age of 59 ½ are tax-free.
Employer match is something you won’t come across in any other kind of investment; it’s a guaranteed, immediate, 100% return on your investment. Why would you turn that down?! Here’s an example of how it works. If your employer will match the first 5% of your contribution and you earn $50,000 a year, the first $2,500 you contribute will double to $5,000.
Fully Fund a Health Savings Account (HSA)
An HSA is a way to save money to pay for out-of-pocket medical expenses when you have a high-deductible health insurance plan. An HSA also reduces your taxable income, and it can be an additional way to save for retirement.
Each year you decide how much to contribute to your HSA up the limit; for 2021, the limits are $3,600 for a single person, $7,200 for a family, and an additional $1,000 for those aged 55 and older.
Any money that remains in the account can be rolled over. Once you turn 65 and enroll in Medicare, you can’t make additional contributions but can continue to use the money to pay for qualifying medical expenses
.The invested contributions grow tax-free, and the money spent on eligible expenses is tax-free. Unlike some other types of retirement accounts, an HSA doesn’t have a minimum required distribution after age 70 ½ and it can give you an extra $3,600-$8,200 per year to contribute to a tax-advantaged account after maxing out your other options.
I call an HSA the Swiss Army Knife of investing because it does so many things; it helps pay ever-increasing medical expenses, reduces taxable income, and gives you another avenue to invest for retirement.
Fully Fund a ROTH IRA
While you have until April to contribute to your IRA that will count towards your taxes for the previous year, it can be advantageous to max out the account as early in the current year as you can. For 2021, contribution limits are $6,000 and an additional $1,000 for those aged 50 and older. Maxing it out as early in 2021 as possible rather than waiting until the tax deadline of the following year to make prior-year contributions means you’re giving your money an extra 15-months to compound tax-deferred.
Contribute to Your ROTH 401(k) up to the Maximum Contribution Limit
Contributing enough to your ROTH 401(k) to get the matching funds from your employer is a priority even when you have other pressing financial concerns like paying off credit card debt or saving for an emergency fund. But once you’ve contributed enough to get the match, if you have those concerns, you should focus on addressing them.
Once you’ve paid off the debt or increased your emergency fund to a level you think is sufficient, revisit your ROTH 401(k) contributions. You have years, possibly a few decades, that need to be funded after you stop working, and your ROTH 401(k) is an integral part of that.
Create and Invest in an Opportunity Fund
As you can see, we prioritize retirement accounts when it comes to investing because of the tax advantages. But retirement isn’t the only thing we can save for, and if we pull money out of retirement accounts early, we’ll face a penalty (with some exceptions). So we need some money somewhere else. We already have money sitting around in our emergency fund, making nearly no interest, so we don’t want to add to that. What we need is an opportunity fund.
An opportunity fund is money we keep in a non-qualified investment account that we can use for anything we want, including taking advantage of a good opportunity (Hence the name!) that might come our way in the form of a great investment opportunity, starting a business, buying a rental property—or retiring early, before 59 ½ when we can access our tax-advantaged accounts without penalty.
You don’t have to have anything in mind when it comes to this money; it’s just waiting in reserve until you find a good reason to put it into action.
It can be just as important to do things in the right order as it is to do the right thing. I hope laying out the correct order of operations investing helps you to better prioritize your financial goals
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