What to do with extra money?
First things first: make sure your bills are paid, and you have a few months expenses saved up in an emergency fund that you can access immediately in case of unanticipated expenses or unplanned job loss.
Because of poor financial education, a lot of people (especially formerly poor people) who find themselves with money leftover end up blowing it. There’s hundreds of modern day examples of this, from jackpot winners to rappers. There’s a great documentary called Broke about multimillionaire athletes who lost all of their money due to flashy lifestyles and poor money choices… One day you have so much money you can hardly imagine how one person could spend it all in their entire life, and the next day… It’s all gone.
So many normal people do this too – and not just with huge windfalls but also with everyday salary increases and year end bonuses. The first lesson: DON’T increase your spending to match your income. If you’re in this position, the fact that you’re reading this instead of on the car lot upgrading to a BMW, you clearly have some long term financial goals.
What to do? Treat yourself, sure: it's good to have a little fun. Just do it within reason: a nice dinner or a weekend trip with someone you care about is great. The rest, however…
So you have some extra money, and you’re wondering what to do with it? Below is the generally agreed-upon optimal order of personal finances (once your bills are paid and you have an adequate emergency fund):
What to do with extra money in savings
1. Contribute to your 401k up-to your maximum employer match (if you don’t have an employer match, this does not apply to you. Skip this step. If in future salary negotiations you have an opportunity to ask for a 401k match, GET IT. This is free, tax advantaged money, hence why it is #1 on the list).
2. Pay down high interest debt. What constitutes “high interest” is different for everyone. Some people say any debt is high interest and opt to pay it off immediately. Some people hang on to some debt if they can get a better return on their money elsewhere, like in an IRA. Pay down your debt in order of interest rate, from highest to lowest.
If your debt includes student loans, read this.
2(a). Health Savings Account [HSA] – Optional: If applicable/desired. To get this you need to have a high deductible health plan (you probably do). You can only spend it on health related expenses like these, but if you pay for medical expenses out of pocket you can essentially use the HSA to reimburse yourself in the future, allowing the money in the HSA to continue to grow tax free. The 2016 limit is $3350. We recommend HSA Administrators for HSAs. Read why
3. Tax advantaged retirement accounts [IRA]. Some people choose Roth. Some people choose traditional. There is a lot of arguments for and against each. If you want to go deep into it, you can do a google search for “traditional vs. roth IRA” and find lots of resources. The short version is: Roth IRA: Pay taxes now, don’t have to pay taxes later. Traditional IRA: Get a tax deduction now, pay taxes later.
4. Remaining 401k. If your work has a 401k, now you contribute to that (regardless of match or no match). 2016 limit is $18k.
5. Taxable stock brokerage account – At this point, and only at this point, do you contribute to this account. This means you have completed steps 1-4 for this year – congratulations, you have no debt and a fully funded HSA, IRA, and 401k. If you don’t yet, knock it off! This account is not yet for you. This is a fully taxable account and is not useful until your tax-advantaged accounts are maxed.
What if I don't have the money to invest yet, or only a small amount of money?
It is OK to get started investing with a small amount of money - as long as you are debt free and have money that is kept liquid (available) for unforeseen expenses (emergency fund). There is no minimum investment and no minimum balance at our preferred brokerage, Betterment. Their robo-advisor software will help even beginner investors average 4.30% higher returns than a typical DIY investor.
Where to invest extra money?
If you have a more complex scenario or feel that your questions were not answered by this guide, find a financial advisor you can trust in minutes with WealthMinder.
Please note that this is general financial advice that is applicable to most people, but it is not a substitute for consulting with a professional financial adviser. Your mileage may vary. Affiliate links may be used on this site when they are offered by the service provider. Read our about us page for further information.