Savings Waterfall

Savings Waterfall

| June 16, 2020
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Whether your stock has just vested or you're ramping up your savings, it's common to wonder, "where should I put this money?" I like to think of a savings strategy much like a waterfall, and every month, every dollar, every payout should be viewed under the same lens...

Savings Waterfall

First, establish a cash reserve goal. You can start with $1,000 if that's where you are, but push to get 6 months of expenses set aside as soon as you can. Having a strong cash reserve is one of the most undervalued aspects of continued success. Don't worry about return ON these dollars, only return OF these dollars, so any FDIC insured account will work.

Tip: If you're retired or getting close, build your cash reserve to 1-3 years of expenses (depending on how much of your current income comes from your investments and how conservative you are). That will help you withstand most bear markets by historical standards without ever having to pull from your investments!

After you've established a cash reserve that you're comfortable with, contribute to your company 401k up to the match. Just up to the match right now. That match, whether it's dollar-for-dollar or less, is the best return on investment you'll ever make. If your company doesn't offer a 401k or you're a business owner, request your company set one up, they're cheaper than you would think and technology has made it easier for companies to administer.

Tip: If you're early in your career and/or expect to be in a higher income bracket in the coming years, consider contributing to your Roth 401k. You'll pay taxes on the earned income now but never pay taxes on the principal or growth in the future!

Now we hit the debt. I realize how hard it is to contribute to your 401k and sit in cash while you have debt, but future-you will thank you. Without a sufficient cash reserve you'll continue the debt cycle, and if you don't take advantage of your 401k early and often, it's very difficult to catch up. Pay down your debt with a debt snowball until your "bad" debt is paid off.

Up until this point, saving isn't a lot of fun. You may not realize it if you're just getting here, but the joy of seeing your money compound is like having a money tree that you don't have to water. I love listening to real estate investors talk about "passive income" by owning a rental property...there's nothing passive about having to answer calls from your property manager when your condo tenant throws noodles out of their 7th story window and you have to replace the stucco all the way down the side of the building (true story). You want passive income? When your brokerage account or IRA distributes dividends directly into your account and then reinvests for you without you knowing...that's REAL passive income.

The next step is contributing to an IRA. Contribution comes with a couple hurdles, like income limits (if you have a company 401k) and annual contribution limits that adjust every year or two. But, an IRA is much like having a personal 401k, with the same pre-taxed status. A Roth IRA is comparable to a Roth 401k and I would point you toward this first, see tip #2 above. IRA contribution limits are combined so you can do a little of both, but if you're eligible to contribute, stick with the Roth IRA until you get phased out.

Here's where it starts to get more creative, depending on your goals. If your main goal is to be on track for retirement, then go back and max out your 401/Roth 401k. If you have kids and want to start investing for their college, put less than the max in your 401k and invest the rest into a brokerage account with a goals-based strategy for college education. College education, a house downpayment, etc. are all "mid-term goals" that should have a dedicated account or sub-account and investment strategy.

Tip: If your company has an Employee Stock Purchase Plan, approach this as another mid-term investment. Contribute to the ESPP until it vests, then sell out of your position and move it to one or more of your goals!

Saving CAN be fun, just like eating healthy, it's all about delayed gratification. If you can make your long-term goals as vibrant and exciting as those commercials you see, it's not a sacrifice.

Dare to dream; enjoy the ride

- Scott

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