Today we want to take you back to basics. When you get paid every month, and you are saving money, where should you put that savings? Every situation a little different, but below is a general guide of how we typically prioritize savings dollars:
1. Set aside 6 months of living expenses in a liquid savings account. This acts as your emergency fund in case you lose your source of income, it gives you 6 months to find another job. The key here is knowing how much you spend each month (we recommend using our eMoney online platform to track your spending and saving). If you don’t have access to this platform let us know and we can set you up.
2. Pay off any debt unless the debt has a lower interest rate than what you could easily earn investing it (for example, you can likely earn more than 3% investing, so debt with lower rates may be better invested). However, this depends on how large the debt is relative to your income. If you have a couple hundred thousand dollars of student loans, you want to get free from that before you focus on investing.
3. Set aside cash you will need for any large expenses in the next 3 years, such as buying a house, a car, etc. You want to utilize a separate savings or investment account for this money so that it can be invested very conservatively. It should be separate from your emergency fund and shouldn't be invested directly in the stock market because you never want to be in a situation where you are forced to pull money out at an inopportune time because of a large expense (i.e. you need a new car right now, but the market just collapsed 30% and the best thing for your wealth would be to let the market recover before pulling the money out, but because you need a car, you are forced to sell at the lows).
4. Contribute enough of your paycheck to your 401(k) to receive the full company match because the match is free money.
5. Fully fund your IRA account (meaning $5,500 per year) if you are under the income limits because this is essentially long-term savings that you won't touch (can't withdraw without a penalty tax until you are 59.5) so you have a long-term investment horizon on it too. This money should likely be invested in the stock market.
6. Fund remaining eligible tax-deferred accounts. Such as, funding the rest of your 401(k) up to $18K per year limit to receive tax deferred treatment on that money. Or if you are a small business owner, fund your SEP IRA or SIMPLE IRA.
7. Excess cash after completing all of the above should be invested into
- a taxable brokerage account (meaning you will have to pay capital gains taxes as incurred),
- rental real estate property (please note that the more rental real estate you own, the larger your emergency fund savings should be), or
- some other form of cash producing asset, such as a business
If you aren't sure if you are going to have a large expense in the near future but want to have the flexibility to pay for a large expense if needed while also investing, you can invest in a taxable brokerage account where the money is liquid, but realize that you don't get the tax benefits of an IRA / 401k, meaning your wealth grows slower. However, this option gives you flexibility because you can pull the money out at any time without having to pay any penalty.
All the best,
Your Fortis Capital Management Team