Have Some Extra Money Lying Around? Here's Where to Put It...
Many people working today aren't as focused as they should be on retirement savings. Before the Great Recession hit, the US savings rate was at 2.5%. It's rebounded a bit now, to 4.1%, but still well below the 10% rate we saw four decades ago. If you have some extra cash lying around, and haven't been saving as much as you should, this guide should give you an idea on where it should go.
Step 1: What's Your Budget?
It's hard to figure out how much you can save if you don't know how much you spend each month. Divide up expenses into required expenses (rent/utilities/groceries) versus optional (eating out, entertainment, shopping). Looking for ways to cut spending is the first way to save more money for retirement. If you're looking for an awesome budgeting tool, try out Mint.com, where you can create a budget, and automatically pull expenses from your credit card statements to see where you are spending your paycheck.
Step 2: Have Some Backup Cash
You never know when something unexpected comes along in your life. Whether it's a surgery, an unexpected trip home to care for a loved one, or a parking ticket, you'll want some emergency cash on hand to help out. I like my money to make money while it sits, so I usually host my backup cash in a brokerage account in low-risk stocks. Stocks are convertible to cash in your bank account within 3 business days. In the interim, you can use your credit card as payment, using the converted cash to pay off your bill when the time comes.
Step 3: Are You Going to School Soon?
If you're going to school soon (either for the first time or back for more), saving for that should take precedence over retirement savings. Hopefully, a higher learning degree will deliver more income in the future, so this is a sound place to put some extra dough.
Step 4: Matching Funds
Many employers these days offer matching funds in a retirement plan, who can match up to 100% of funds contributed by the employee. These matching funds usually vest over a number of years, and can really boost retirement savings. That's why it's important to take full advantage of what your employer is offering in terms of matching funds.
Step 5: Where's Your Debt?
Paying down any high-interest debt, like credit cards and student loans, should be your next step with your extra cash. Start by paying the minimum payments on every loan or bill you have, and then choose between two different methods- avalanche and snowball. With the avalanche method, you pay off the highest interest loan first, and then move down the list until you are debt free. With the snowball method, you reduce your smallest loans first, the ones that you can pay off the quickest, which adds a psychological element to the mix and may actually encourage you to save more towards your debt-free goals. Want to see how long it will take? Check out Unbury.us.
Step 6: Fund Your IRA
If you have more cash left over, open up an IRA and contribute as much as you can towards the maximum allowed per taxable year ($5,500, or $6,500 if you're 50 or older). There are two types of IRAs- Traditional and Roth IRAs, both of which you can withdraw from when you are 59.5 years of age. A traditional IRA defers taxes until you withdraw the funds (on both your contribution and earnings), a Roth IRA taxes that income now and allows you to withdraw those funds in the future without any more taxes.
Which one should you choose? It depends on your tax bracket. If you make a lot of money now, a traditional IRA may be the way to go, since you may be in a lower tax bracket when you withdraw. A Roth IRA is good for those of you expecting to be in a higher bracket in the future.
Step 7: Max Out Your 401k, or Other Goals?
You can contribute up to $18,000 into your 401k each year. You may wish to max this out if you're a high earner, or you may wish to save for other things at this point (a house, a baby, your kid's college fund).
That's a rough primer on what to do with your extra money. Have any tips you'd like to share? Fire away in the comments!