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Where should my next dollar go? (the cashflow waterfall)

November 02, 2023

When it comes to saving money, I often hear people express frustration because they either don't know where to start or if they have started, what to do next. Here is my thoughts on how to prioritize saving money. I call it a savings waterfall. And, like many waterfalls, this doesn't necessarily fall in a straight line. Meaning, if you are able, it probably makes sense to focus on a few "streams" at a time:

1. Take advantage of your company’s retirement plan match

There usually isn’t such a thing as free money. But your company’s retirement plan match is just that. Most companies offer a 100% match between 3-5% of your income. For example, if you make $100,000 and are offered a 4% match, your company will match you, dollar for dollar, up to $4,000, which means your investment will be worth double at the end of the first year, without any investment earnings.

2. Build a small emergency fund

A good starting point is $3,000 in a high yield savings account. This helps you pay for “what if” situations that may arise like an auto repair.

3. 10x income in low-cost term life insurance

Even if you don’t feel you need life insurance today, insurance is always cheapest when you are young and healthy. Buying a 20–30-year policy will ensure you have a baseline amount in place to protect your future.

4. Pay off all high interest debt

For me, that means anything above 7%. Focus on aggressively paying down this debt. Dave Ramsey’s snowball strategy is a good strategy for paying off debt.

5. Max out a Roth IRA (up to $7,000 for 2024)

Building a future tax-free pool of money is a great idea. Plus, there are unique liquidity options associated with a Roth account.

6. Max out an HSA (if available.)

The HSA is the most tax-efficient account there is. If you can, resist the urge to use it for short-term medical expenses. Instead invest your funds for the future.

7. Build a 3–6-month emergency fund

This will provide you with further flexibility and help ensure you don’t have to go back into debt to cover unforeseen issues or loss of income due to job loss.

8. Build nonqualified savings

This account provides flexibility. You can put as much as you want into it. How this account should be invested depends on your short- and long-term financial goals. Depending on your tax situation, it may make sense to skip this step in favor of the next, or combine the two.

9. Max out your company retirement plan

With all previous steps completed, if you are still looking for savings, I would go back to your employer sponsored plan and add more up to the contribution limit.

10. Get completely debt free

Pay off all debt. However, if your only debt is a 3% mortgage, I'm not so sure I'd be in a hurry to pay it off.