It's time to “get your financial house in order.” But, what exactly does that mean?
There's a lot that goes into the process of getting your finances in order, but the first step is to be sure your financial house is built on a solid foundation. This means that you have six fundamental pillars (accounts) in place that are designed for sustaining your financial well-being and creating wealth.
#1: An emergency fund. These funds may be part of your savings account mentioned below, but are set aside specifically for the unexpected. You know that label you see on fire extinguisher boxes – “break glass in case of emergency?” Only in a financial emergency should you “break into” these funds. What is a financial emergency? Everyone’s definition varies, but examples include hospital bills, major car repairs, and unemployment. We recommend 3-6 months of your income need be held in this account.
#2: A savings account. This is your financial Fort Knox: the place where you store and build the cash you may someday need for larger purchases. Savings accounts pay a very small interest rate. We would still advise that you have a savings account, even in today’s low-interest rate environment. As this account grows larger than the recommended "3-6 months" amount, you might consider what we call a hybrid approach to savings that Drew discussed in detail here.
#3: A checking account. This is your go-to account for everyday expenses, whether you pay your bills digitally or the old-fashioned way. Some accounts may have minimum balance requirements, so it's best to closely read the new account information. A checking account is a great tool for automating bill payment and regularly scheduled investments.
#4: A workplace retirement plan account. If your employer offers some type of retirement account with a match we highly recommend that you take advantage of this benefit. The account may be a 401(k), Simple IRA, 401(b), etc. Regardless of the type of plan, a workplace retirement plans is a convenient way to save for the future. In most of these plans, your contribution is made with pre-tax dollars, but depending upon your situation, you may have the option of choosing an after-tax investment.1 The amount you choose to invest is taken right from your paycheck making it a very painless way to invest. Consistent monthly investment is the “fuel” for your account.
You will be asked to choose an investment strategy for this retirement account. Check out our Easy401k service for information about how we can help you choose the right investments in your workplace account.
#5: An Individual Retirement Arrangement (IRA). This is a tax-advantaged retirement savings account that you own. There are traditional IRAs (up-front contributions are not taxed; retirement withdrawals are) and Roth IRAs (up-front contributions are taxed; retirement withdrawals are not, provided federal tax laws are followed).2
Thanks to the SECURE Act, you may contribute to Roth and traditional IRAs all your life, as long as you meet the earned-income requirement for account contributions.2
#6: A taxable investing account. This is also popularly called an investment account or brokerage account. A taxable investing account gives you access to a wide range of investment products, which can help complement the other accounts in your financial foundation. As mentioned in step #2 above, this account provides a powerful tool to help you accomplish your long-term financial goals.
Regular monthly investing does not protect against a loss in a declining market or guarantee a profit in a rising market. Individuals should evaluate their financial ability to continue making purchases through periods of declining and rising prices. The return and principal value of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.
Citations1.Tax Policy Center, May 2020
2. Internal Revenue Service, November 10, 2020