Prioritizing is important when involving your finances. Your next paycheck and either go towards that new $600 watch you want or to pay off some credit card debt. The logical thing to do is to put that money towards the debt and don’t incur any more debt. The main problem is some people choose to ignore their issues or act on impulsive emotions. Here is some simple math to help you get from sinking underwater:
Expenses < Income
In other words, keep your expenses less than the money you take home. Spend less than you make. Live below your means. Only spend what you have. Whatever you want to call it, it’s simple math.
Now if you do this properly, it should give you a good amount of money to save each month. The question is what do you save for and why do you need to save. Depending on where you are in your life and what you want to achieve, it can be different for many people. But here are some examples:
- Saving up for a down payment on a house
- Saving for a rainy day — unexpected medical expenses, emergencies, loss of job, etc
- Saving for retirement
- Saving for children’s education
- Saving for a big purchase — car, boat, ring, etc.
- Saving for a wedding
Those are some of the more common reasons to save. Now some of these things in the list don’t apply to me — I don’t have children and not looking to marry soon. I do have a plan for the next 5 years and buckets on where my money should go. This list is prioritized and once the first bucket is full, I’ll move on and fill up the next bucket. I may decide to fill up each bucket at the same time, but it’s important to get that first bucket full before continuing on. Here are my 5 buckets:
- $10,000 saved in a high-interest yielding liquid account to act as my “6-month emergency fund”
- Max of $4,000 each year in my Roth IRA
- $200,000 down payment for a house
- Max of $16,500 put into my 401(k) every year
- Put $10,000 a year towards long term investments – stocks/bonds/mutual funds
If you add that up, I’m aiming to save $362,500 in 5 years. I need to be making a million dollars a year to save that much, right? Well yeah something like that. But since I already have some money in each of these buckets, I can still get by with what I’m making.
Usually, maxing out your 401(k) would go after maxing out your Roth IRA, but I’m looking to buy a house in the next 5 years so I have shifted that up the priority ladder. Also note that I am in California so a typical 20% down payment on a million dollar house would be $200,000. For my first home, I may only need half that down payment for a smaller house, but I like to aim high.
Your list might be different. Sit down and prioritize what you want in life and stick to the plan. Save a little bit each month make that amount consistent. What you will see is the total amount compounding as you keep working towards your goal.