What up fam! Where do we start on our journey toward financial success? How do we prioritize spending, saving, investing and paying off debt? What does that personal finance ladder look like? If I have extra money at the end of the month, where do I put it? Whether you’re just starting out in your first job, or 15 years into a career path, there are a series of standard milestones as we all journey toward stability and possibility in our finances.
In the beginning of my own journey, I struggled with prioritizing all of my financial goals. Should I invest in the stock market before I pay off my car loan? Do I need a 6-month emergency fund before I start contributing to my employer’s 401(k) plan? At what point can I start saving for the big expenses I have coming up?
Let’s simplify personal finance.
I sound like a broken record, but I’ll say it again for the people in the back: personal finance is personal! That means your journey may look different from what’s outlined here. I’ve learned over the years that having a standard roadmap to reference can be helpful in making sure we’re focused on the right things, and that’s what I’ve drafted here. HOWEVER, please know this post was not written for your specific scenario.
My hope is that this outline gives you some options to think about and consider. I would love for this to help you prioritize your goals or motivate you to turbocharge your financial journey so you can reach your goals faster.
Another note I want to make before we jump into this topic – it’s really easy to get caught up in the weeds of personal finance. We can argue about investment vehicles and fee ratios all day. It’s easy to make it complicated (and in fact, many big financial institutions benefit from making it complicated!).
But at the end of the day, what matters is that you’re taking steps in the right direction. The personal finance ladder outlined below is designed to remove confusion from the equation. It’s a SIMPLE outline of the simple steps you can take in your financial journey.
The Personal Finance Ladder: How do we prioritize saving and investing?
Rung #1: Employer 401(k) match
Alright fam, if you’ve got FREE money on your table, you better be accepting it. Not all employers offer this, but when it’s available, take advantage of it! Many times, a company will match 100% of your contributions up to a certain percentage of your annual income. Check with your HR department to see if this is available to you and then adjust your contribution to be sure you’re capturing all of that free money.
Here’s an example to illustrate just how important this is. Let’s say your employer matches 100% of your contributions up to 5% of your salary. If you make $40,000, that’s an extra $2,000 per year of FREE MONEY you’re getting. AND, because of the magic of compound interest, after 20 years, that same $2,000 will be worth $7,739 (assuming a 7% growth rate).
If you’re not comfortable funneling the full match percentage over to your retirement account, start out with just 1%. Gradually increase the contribution amount by 1% every couple of months, and pretty soon, you’ll be there! Decreasing your take-home pay can be difficult. But in the long-term, it’s SO worth it. And if you do it slowly, you won’t even notice the change. I encourage you to give it a try.
Rung #2: 3-month emergency fund
Next up! You need to build an emergency fund that can support you for roughly 3 months. If you’re on this rung of the personal finance ladder, this means you’re actively saving money and putting it away for a rainy day. How much money is 3-months worth of expenses? It’s different for everyone, so be sure to track your past expenses to determine the goal amount.
An emergency fund is what helps pay for those unexpected crises – an emergency room bill or a layoff. It’s your cushion for survival in case of emergency. Regardless of how urgent you feel it is, a vacation on the beach is NOT an emergency. We’ll get to the fun stuff later.
Remember, if we ever have to dip into our emergency fund, we’ll revisit this rung on our personal finance ladder to shore up the account.
Rung #3: Pay off high-interest debt
For the sake of conversation here, we’re going to use 4% as our guideline. Take a look at every debt item you have. Check out the interest rate, minimum payment and remaining balance. If you’ve already taken steps toward paying down your debt, you likely already have this information compiled. But if not, take some time now to gather all the information.
Here’s a downloadable debt tracker you can use. No strings attached! I just want you to have the tools you need to be able to do this easily because it’s so important.
Once everything is compiled, let’s highlight any debt item that has an interest rate higher than 4%. This is likely any credit cards, store cards, private student loans, medical debt, etc. Anything with an interest rate lower than 4% can be set aside for now. Don’t worry, we’ll get back to them soon.
Using a debt payoff strategy, like the one outlined HERE can help you effectively and efficiently wipe out that debt that’s holding you back.
One note here – I’ve chosen 4% here as a safe guideline from a mathematical standpoint. It’s likely possible to invest your money and gain more than 4% interest. So, rather than use that money to pay off debts that have lower interest rates, we can invest it and make more than the interest you’re paying. If it feels more comfortable to you to set a different guideline, go for it. Everyone’s threshold is different, and this is your world!
Rung #4: 6-month emergency fund and sinking funds
If you’ve made it to this rung on the personal finance ladder, that means all of your high-interest debt is GONE. Pause here while we celebrate that accomplishment. I knew you could do it!
Now we turn our focus back to the emergency fund. On this rung, we’re going to heavy up that emergency fund and look ahead to any big expenses we know are coming our way. While a 3-month emergency fund is terrific, 6 months is ideal. We want you to have as much of a cushion as we possibly can in case of emergency.
This is also where we’re going to start thinking about any of those regularly occurring, yet infrequent expenses. Think about things like your car registration, personal property taxes, replacing appliances or a vehicle, annual doctor visit, kids’ Christmas or birthdays, etc. We see these expenses coming so they’re not unexpected emergencies.
In the personal finance world, setting aside money for this type of expense is often called a ‘sinking fund’. You can call it whatever you like, as long as you set it aside. If you’ve got a $200 license renewal fee coming up in 4 months, you know you need to save $50 per month to be prepared for that expense.
Once we feel a little bit more comfortable and confident that we’re prepared for any upcoming expenses or emergencies, we’ll move on to the next rung.
Rung #5: IRA
This is where it gets FUN. We’re going to start investing your money and watching it grow all by itself! An IRA (individual retirement account) is a long-term investing account.
There are two types – a Roth IRA or Traditional IRA. Bottom line here is there are some benefits to both, and depending on your income today and your anticipated income, one may be better than the other for your particular situation. Do some research on the types of IRA accounts and talk to a financial advisor. But DO NOT let that decision delay you from investing the money at all.
Money invested in an IRA today – no matter the type – is worth more tomorrow than letting the money sit in a savings account. What have we learned already about the value of time in the market? It’s one of the most important aspects of our personal finance journey!
In 2021, we can invest up to $6,000 as individuals into IRAs. If you’re over 50, you can contribute $7,000. A Roth IRA does have a salary limitation; you can’t contribute to a Roth IRA if you make more than $140,000. Check out the IRS limits, which do increase every so often, here.
Rung #6: 401(k) max
At this point, we’re most likely already contributing SOMETHING to the 401(k) to get our employer match. But now’s our chance to make some real money moves on the personal finance ladder. Maxing out your 401(k) is the best kind of challenge.
Not only are you benefitting from an EASY way of investing money in the market, you’re also effectively DECREASING the amount of income you’re paying taxes on. That’s right. Any money contributed to your 401(k) is pre-tax – we only pay taxes on it when we withdraw it.
Employer 401(k) plans are great because the money never hits your account – it’s taken directly from your paycheck and deposited automatically. So, this particular rung on the personal finance ladder is a simple one!
In 2021, the maximum contribution is $19,500. So, with some simple math, you can figure out what percentage of your paycheck you want to contribute and sit back and enjoy.
If you aren’t yet able to max out the account, don’t worry! We can still experiment with increasing your contributions. Start out with increasing your contribution by 1% on a monthly basis. Keep doing this until things start feeling a little uncomfortable and then, if needed, back down a level. By increasing your savings rate, you’re still making an impact on your financial future!
Rungs #7 & #8: Lower-interest debt and/or post-tax investments
This is a real party, now. We’re knocking those milestones out of the way on our way to financial freedom and it feels great. Let’s keep going!
This is where you’re going to tackle any lower-interest debt items. Maybe it’s a student loan or a car loan or something else. Most home mortgages would also qualify, although the jury’s out on whether it makes sense to pay those completely off. As with many things in the personal finance world, it’s a decision that will vary depending on your priorities and goals.
This is also where we’re going to begin contributing to post-tax investments – a brokerage account would count. The reason we prioritize our retirement accounts (IRA & 401(k)) over the post-tax investment accounts is because of the tax advantages; however, once you’ve maxed out those options, we can use investment accounts to continue to invest and grow our money.
I’m combining these two personal finance ladder rungs here in one section because these can be reversed or combined in any number of ways, and depending on your age and goals, one might make more sense over the other. A financial coach or advisor can help with prioritizing this stage of your money management!
In conclusion
Now that we’ve taken a look at my personal finance ladder blueprint, take a stab at a draft of a ladder for your own life. Mileage may vary, and with so many variables, your final personal finance ladder may look different from what’s laid out here.
Again, for simplicity sake, I’ve kept this personal finance ladder example fairly streamlined. There are other options that you may have access to, and should consider. Things like Health Savings Accounts, college savings, real estate investing, etc. I also encourage you to talk with a financial advisor about the different types of investments to optimize your money for your lifestyle and goals.
Report back in the comments on which rung of the ladder you’re tackling now!
Related post: Easy New Year’s Money Moves You Should Make