IT CAN BE SIMPLE

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Many of the personal finance gurus and talking heads have a step-by-step guide or process to pay off debt or build wealth.

Perhaps the most famous process of all is Dave Ramsey’s manifesto - The Baby Steps.

I don’t like saying this phrase out loud or typing it on the page, but the ideas took the world by fire. Ramsey’s 30+ year run on daily radio programming is ample evidence.

An alternative to Ramsey’s copyrighted program is The Financial Order of Operations, created and popularized by The Money Guy (the Youtube channel of the RIA Abound Wealth in Franklin, TN).

This program allows for a bit more flexibility and is created/optimized for “Financial Mutants” who crave opportunities to save, invest, and make financially wise decisions.

Both of these frameworks are useful. There are probably countless other processes promoted and taught by financial advisors and other financial influencers.

Managing your financial life can be as simple as a seven step plan. It is a good reminder that money doesn’t have to be overly complex or difficult.

There are two main components of your financial life: 1) Investing and 2) Financial Management. The content below will provide further explanation or exploration on the foundation provided by others.

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INVESTING

1 - Employer Match

An employer match is the amount your employer will contribute to your retirement plan if you contribute to your retirement plan.

Typically, it is something like “Will match 100% of the first 5% of contributions” or “Will match 50% of the first 6% or first 8% of contributions” or some other formula like these.

Essentially, this is free money or an additional, incremental salary. When your employer matches your contributions, you receive an immediate return on the dollars you invest.

Contributing up to the employer match point is the simplest (and possibly most obvious) step on the path to building wealth. If you have a 401(k), 403(b) or some other employer-sponsored retirement plan AND your employer will match a percentage of your contributions, it is beyond a no brainer to start saving.

2 - Tax-Free Growth

You probably recognize the Roth IRA, the Roth 401(k), and the HSA. These are three of the most common investment vehicles offering tax-free growth to investors.

The word “Roth” basically means that you will pay taxes today and then invest. Since you pay taxes in the present, any future withdrawals and any growth will be tax-free.

The Roth IRA is the king of investment vehicles. It is such an amazing tool that the government limits its use. If you make more than $144,000 (tax filing status = single) or $208,000 (tax filing status = married filing jointly) in income, the IRS no longer allows you to contribute to a Roth IRA.

Once you make a contribution into your Roth IRA, you will never pay any additional taxes on your withdrawals (after age 59½). This means that all the growth you experience in the account will be tax-free, creating some serious potential tax savings.

The Roth 401(k) is the after-tax alternative to the 401(k), which you are probably familiar with already. The Roth 401(k) is still a payroll deduction, employer-sponsored retirement vehicle. You will pay taxes on your earnings, and then your contribution will be deposited/invested. (Just so you know, your employer’s contribution will always be made to a Traditional 401(k) account because your employer wants to save on taxes now.)

Although not as popular as the Roth IRA, the Roth 401(k) provides similar benefits.

Last but certainly not least, the HSA (Health Savings Account) is another investment vehicle that provides the opportunity for tax-free growth. If you have a high deductible healthcare plan, you will probably qualify to open an HSA.

Your contributions are tax deductible (this means that either a) you will receive a tax credit and reduce your taxable income or b) your payroll contribution will occur before you pay taxes) and your withdrawals will be tax-free if used for healthcare related expenses.

As an added benefit, you are not penalized if you end up using HSA funds for non-medical expenses after age 65. You’ll pay ordinary income tax, but those funds will have received the benefit of being invested over a long time period.

In retirement, the HSA may be viewed as a type of emergency fund (more on those later) where any medical related expenses will use HSA funds first.

Utilizing these tax-free growth accounts should be a first priority. There are many arguments/discussions about how to maximize utility by making contributions to certain accounts, but it is a consensus opinion that tax-free growth (Roth) accounts are the best place to start investing.

3 - Tax-Deferred Growth

The accounts providing tax-deferred growth are familiar too. The IRA and 401(k) are probably the most common.

You may hear the word “traditional” used to describe either of these accounts. This simply means that your contributions will occur before you pay taxes. You will not pay taxes in the present but will in the future.

Because both types of IRAs (Traditional and Roth) have the same contribution limit, you have a very limited capacity to contribute to both. Although it may not be a core focus initially, you may open a Traditional IRA at some point in your financial life.

Most of the time, folks or their employers just leave the “traditional” out of it. If anyone you know says, “401(k),” chances are great they are referring to the before-tax (tax-deferred) version of the retirement account.

As soon as you have a full-time, post-graduate position, you will probably have access to a 401(k).

4 - Max Out Retirement Accounts

At some point (probably sooner than you expect) you will reach an income level where it is relatively easy to max out your Roth IRA, 401(k), HSA and/or other investment accounts.

All of the typical retirement accounts have limits.

These accounts have different qualifications/criteria and specific use cases. Regardless, maxing out one or many of these accounts is a huge step toward financial independence.

5 - After-Tax Brokerage Account

If you still get the itch to invest after maxing out your retirement accounts, you can contribute funds to a taxable brokerage account. Although there are no tax advantages, these accounts still serve a purpose in your financial life.

Investing is always a valuable activity. If you have no more room to invest in tax-advantaged accounts, the standard taxable brokerage account is a good place to gain additional momentum.

6 - Build Wealth via Ownership

Ownership provides the most sure path to wealth. Basically, wealthy people own things.

At some point, instead of putting your next dollar in a taxable brokerage account, you may decide to invest in a real estate asset (multi-family property, single family rental property, commercial property, etc.), a private company/business, or some other real asset.

Ownership has many advantages. It provides access to an asset’s cash flows. When a property provides rent or a business generates cash flow, the owner pays any expenses and receives the net income.

Typically, ownership can provide for a higher potential ROI because all (or some) of the profits flow directly to you. While investing in the stock market is a great way to invest, the company executives and the company itself are responsible for decision making overall and pulling profits out along the way.

The stock market is a valuable tool due to its simplicity, but other asset classes do offer a higher degree of control and potentially higher returns. Owning any asset does not come without risk, but any incremental risk should provide opportunity for additional return.

If you are presented with the opportunity to own an asset, you should carefully consider and assess the potential risk/return of investing your dollars into the asset. Do you have the skills, knowledge, or expertise? What do you stand to gain? What do you stand to lose? Is the asset worth the investment of your time?

Ownership beyond the stock market is the final stage of investing. Capital allocation (i.e., the process of distributing and investing financial resources to maximize efficiency and profit) becomes the focus.

FINANCIAL MANAGEMENT

1 - Emergency Fund

The typical recommendation is to save three to six months of expenses in an emergency fund (simply a checking or savings account which you can gain access to quickly).

Different stages of life may determine how much you save in an emergency fund.

While you are young, dollars invested have higher potential total returns so you may opt to keep your emergency fund relatively small (say three months) and prioritize investing.

As you grow older, investing is still important but the opportunity cost is not as high. You may keep your emergency fund relatively large (say a year or more) and prioritize safety/comfort.

The advice for emergency funds is rarely as life/situation specific as it should be. You can use your own circumstances, personality, and risk appetite to determine the amount you should save in an emergency fund. It probably won’t be a constant amount or percentage but will expand/contract alongside changes in your life.

2 - Debt

Dave Ramsey besmirches debt in all its forms, outlawing credit cards, student loans, and other high interest debt. He frowns upon home loans generally, encouraging borrowers to use the 15-year home loan and pay down the mortgage balance aggressively.

This is probably too dogmatic a view for the high-achieving, future-focused readers of The Wealth Span.

Should you wildly accumulate debt to fuel lifestyle expansion or unnecessary purchases? No, probably not.

Is it okay to wisely use credit cards for travel rewards and take out a 30-year mortgage? Yeah, probably so.

We all can recognize “dumb” debt. It is easy to identify.You should avoid dumb debt entirely and pay it off quickly (this is where Ramsey’s plan really works) if it is already on your balance sheet. Other forms of debt should be carefully managed and utilized with wisdom.

3 - Buying a Car

Cars can be expensive. Buying a car creates headlines in the financial world and makes for an easy segment on a radio show or podcast. It holds a large portion of the mind share of everyday consumers.

The car purchase is a “flex” of sorts. Because the actual vehicle is so clearly tied to its owner and highly visible to others, the car you own can be an easy way to “keep up with the Joneses” or display status.

Buying/using a car is a great example of diminishing marginal utility or satisfaction. Initially, you can spend more and doing so will provide more satisfaction. There is a ceiling though. At some point, spending more will not provide any extra value or satisfaction.

If you sell an old beater to buy a relatively new vehicle, you will probably be much happier. If you upgrade from a nice, standard vehicle to some sort of luxury car, you’ll probably not receive the same incremental satisfaction.

This is the trap in the car buying world. The “new car” feel is incredibly tempting, but the fulfillment fades quickly. If you are tempted to overspend or frequently upgrade in regards to your vehicle, remember that the good vibes after the purchase won’t last long.

4 - Buying a House

The first home, and often every ensuing home purchase, is the most significant financial decision you’ll ever make.

Home ownership seems to be an idyllic state where the grass is always green and life is nearly perfect. Some make it seem as though owning a home provides the relief of an oasis in a desert.

If you have already purchased a home, you realize that there may be certain benefits to owning a home. You have locked in a monthly payment and are not at the mercy of a rental/property management company.

There are also some disadvantages. You are exposed to tail risks (e.g., replacing a roof, having water damage, etc.) and are required to incur lots of incremental costs (e.g., buying a lawnmower, completing any home updates/upgrades, buying extra furniture, etc.)

Buying a home is an intensely personal decision. It is probably more about your lifestyle rather than your finances.

If your lifestyle and personal preferences lead you to buy a home, there are a few broad principles to follow.

Generally speaking, your home-related expenses like the mortgage payment, homeowner’s insurance, and property taxes should be approximately 25% to 30% of your before-tax monthly income. Although not perfect, this is a good estimate.

Some would recommend a 20% down payment regardless of your age or financial condition. Others argue (myself included) that first-time home buyers can make a smaller down payment, and then use the building home equity to make a larger down payment on the ensuing home purchases.

The current housing market makes for a difficult entry for first-time buyers. There is no need for extra pressure to save 20% of a home’s cost for a down payment.

Renting is a perfectly acceptable outcome and in some cases even the optimal financial decision. Focus your efforts on solving your housing situation for your lifestyle, not your financial situation.

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TL;DR

INVESTING

1 - Utilize Tax-Free Growth (Roth) Accounts

2 - Utilize Tax-Deferred Growth (Traditional) Accounts

3 - Contribute to the Max

4 - Start Funding a Brokerage Account

5 - Build Wealth via Ownership (small businesses, real estate, etc.)

FINANCIAL MANAGEMENT

1 - Establish an Emergency Fund

2 - Pay Down Debt

3 - Buy a Home/Vehicle or Other Large Purchases

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This is intended to be a foundational piece on financial management and building wealth.

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