Looking to learn what to do with extra money? Oh, what a problem to have! I realize most people are just trying to make ends meet. Nearly 80% of Americans are living paycheck to paycheck. For most of my life, I was one of these people.
Then something strange happened. I caught a really lucky break and ended up in one of the fastest growing fields in the country. For the first time in my life, I was making more than I needed for my rent, bills and food every month. And I had no idea what to do with the leftover money.
So for three years, I sat on it. I put it all in my banks’s savings account and just left it sitting there.
A personal note about me. Every few months I get absolutely obsessed with a topic (chess, poker, dance, etc) and spend every single free minute I have researching it. I’ve been that way for as long as I can remember. While it’s not a great trait for mastering a subject, it’s really nice that I get to develop a novice level of knowledge in a variety of fields! Last year I became obsessed with stock and real estate investing. Specifically with the concept of financial independence.
I read a lot of books, I listened to dozens of podcasts and talked with a lot of financial folks in my local community. Here’s what I came up with as a simplified list of what to do with extra money:
- Figure out how much money you actually spend every month. This can be really challenging but tools like Mint and YNAB can be really helpful figuring out what your budget really is.
- Save up 3-6 months of savings as an “emergency fund”. Before we talk about investing any money, it’s vital to have some cash set aside in case you lose your job or are hit with an unexpected cost. Don’t put that money in a regular savings account though! Instead, put it in a heigh yield savings account like Betterment, Wealthfront or Ally. These accounts earn up to 1.83% interest, compared to the 0.01% you’ll get with a traditional savings account.
- Pay off any bad* debts. Student loans? Personal loans? Credit card debt? Don’t pay those absurd fees. And don’t begin investing while you have a lot of debt. It’s a stressful game trying to earn more in the market than they take from you in interest and fees. Focus on paying those off as soon as possible.
- Take advantage of any tax exempt or tax deferred accounts your employer offers. Does your employer offer 401k matching? Whatever percent they offer, take advantage of that!
- Finally, take all the rest of your money and invest it in index funds. Don’t worry about mutual vs index funds. Don’t worry about which ones. It’s not about picking the perfect fund. It’s about investing your money into something safe that will predictably grow at a rate faster than inflation. VOO? VTI? Just pick one.
*What are bad debts? I consider car and mortgage loans (if you got a good interest rate) to be good debts. If you have a 1% interest rate on your car, but know you can make 5-7% in an index fund, it’s fine to keep the car loan. If you have student loans, credit cards or personal loans with high interest rates, those are bad! Pay those off as quickly as possible before worrying what to do with extra money.