The Financial Order of Operations: Your Step-by-Step Guide to Financial Freedom
The Financial Order of Operations Explained: Make Your Money Work for You
Make Your Money Work for You: The Financial Order of Operations Explained
To make the most out of extra money that comes your way, such as a bonus from work or tax refund, it’s important to prioritize your financial goals. The financial order of operations provides a framework to help you do that. This ten-step framework helps you prioritize your financial goals and make better-informed decisions with your money. Use the financial order or operations to prioritize every single dollar that comes your way.
Every dollar is an employee and needs to be given a job. Here are the ten steps:
Step 1) Create a budget to figure out expenses:
A budget is simply a plan for your money, outlining your income and expenses. It allows you to see exactly where your money is going and helps you make informed decisions about your spending.
Creating a budget allows you to identify areas where you may be overspending, giving you the opportunity to make adjustments to your spending habits. Furthermore, a budget helps you prioritize your expenses based on their importance. By knowing where your money is going, you can allocate your funds accordingly.
Step 2) Build a 1-month emergency fund:
An emergency fund is a safety net to cover unexpected expenses such as car repairs, medical bills, or job loss. Without an emergency fund, you are forced to rely on credit card debt, which leads to high-interest debt and financial stress.
Step 3) Maximize employer 401k matches to let free money compound:
By maximizing your employer’s 401k matches, you’re essentially allowing free money to compound and grow tax-free until you decide to withdraw it. This is a powerful wealth-building tool that can generate a substantial amount of money over time, thanks to the effects of compound interest.
This means that not only are you benefiting from the contributions you make to your 401k, but you’re also taking advantage of your employer’s contributions to amplify your retirement savings. Failing to maximize your employer’s 401k matches could mean leaving money on the table.
Step 4) Pay off high-interest consumer debt:
It’s important to tackle high-interest consumer debt as soon as possible. Credit card debt and personal loans often come with high-interest rates, which can quickly add up and spiral out of control. The longer you carry this debt, the more you pay in interest and fees, which can further compound and negatively impact your credit score.
Carrying high levels of debt can negatively impact your credit score, making it harder to secure future loans or credit with favorable terms.
Step 5) Save 3 to 6 months of expenses in an emergency fund:
A 1-month emergency fund helps with short-term unexpected expenses, but 3 to 6 months provides peace of mind to cover essential living expenses like rent/mortgage, utilities, groceries, transportation, and insurance.
Step 6) Maximize Roth IRA contributions for retirement:
To maximize your Roth IRA contributions, you should aim to contribute the maximum allowed amount each year, which as of 2023 is $6,500 for individuals under age 50 and $7,500 for those over age 50.
By contributing the maximum allowed amount each year, you can take advantage of tax-free growth and withdrawals in retirement. It’s important to start contributing to a Roth IRA as early as possible to take full advantage of the power of compound interest.
Step 7) Make sure you invest 15% of your income for retirement:
When planning for retirement, investing 15% of your income is a good starting point. To reach this amount, you can first maximize contributions to your Roth IRA and take advantage of your employer’s 401k match. If necessary, additional funds can be allocated to your 401k to achieve this desired 15% overall investment.
However, it is important to remember that this is not a hard and fast rule and should be adjusted according to your own individual financial situation and retirement goals. Factors such as your age, income level, and retirement timeline should all be taken into consideration when determining the appropriate savings amount.
Step 8) Invest for long-term goals or pay off medium-interest debt:
Consider long-term goals and whether it’s more beneficial to pay off medium-interest debt or invest for the future.
Medium-interest debt is generally defined as loans with rates ranging from 6% to 8%, such as student loans, car loans, or personal loans. While paying off debt may offer a sense of immediate relief, investing for the long-term could provide greater financial security and increased returns in the future. This decision is especially relevant when aiming to achieve significant milestones, such as saving for a down payment on a home.
Step 9) Pay off low-interest debt:
Low-interest debt is debt with an interest rate lower than the expected rate of return on your investments. In general, it makes more sense to invest in something that earns more than the interest you’re paying on a low-interest debt.
If the debt’s interest rate is exceptionally low, it may be more beneficial to invest the extra funds in other areas, such as retirement savings or emergency funds. Conversely, if the debt’s interest rate is moderate or high, it’s best to prioritize paying it off to avoid accruing additional interest and compounding debt.
Step 10) Do whatever you want:
You can allocate your extra money towards whatever you want. It could be a dream vacation, a new car, a down payment on a house, or anything else that you have been saving up for. The choice is entirely personal and depends on individual preferences and goals.
You’ll be working for money your whole life unless you make money work for you. A clear roadmap can prioritize your spending and maximize your money.
Following the financial order of operations reduces stress and speeds up achieving your goals. It also guarantees a strong financial foundation that is essential for long-term success.
Keep in mind that the financial order of operations is a general guideline as everyone’s financial situation is unique.
What financial order of operations has worked (or not worked) for you?
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