A Twitter follower recently sent me a DM and asked where they should be putting the money they’re saving. I told the follower how my husband and I allocate our savings and decided to flesh the process out a bit more. Here is our model, which you’re welcome to follow or tweak if you feel it would work for you.
1. Save a 1-month emergency fund
You can’t build a house with a poor foundation, and you can’t build your wealth on one either. The first step is to save up at least one month of emergency savings. If you start investing before you have an emergency fund in place, you could end up having to sell investments to pay for unexpected expenses or use high interest credit for them. I suggest a high-yield savings account, like Ally.
2. Max 401k/403b match
The most popular retirement account to receive a match in the US is the 401k. Here’s how a 401k works. Your employer withholds part of your paycheck and puts it into an investment account in which you choose where your money is invested from a list of options (we suggest low cost market index funds). The amount you tell your employer to set aside is not taxed currently, rather, income taxes are levied when you withdraw, which you can do penalty-free after you’re 59 ½ years old.
If your employer offers to match your contribution to a retirement account, you should contribute at least that much. Yes, 401k’s and other retirement funds generally have higher expenses than low-cost index funds, however, the return is a no brainer. Let’s say employer matches 3% and you make $50,000. This means your first $1500 (3% of $50,000) invested has a 100% return because your employer also contributes $1500. There aren’t many ways you can double your money, but this is one of them.
3. Optional: 3-month emergency fund
The next step in your savings ladder should be to round out your emergency fund by beefing that thing up to 3 months of living expenses. If you were to lose your job, for example, you wouldn’t have to dip into any investments or use a credit card to fund living expenses.
My husband and I have only a 1-month emergency fund for the following reasons: A) We want most of our money invested and earning money, not sitting in a savings account. B) Our jobs are fairly secure, so the odds of losing both at the same time are slim. C) We don’t have kids. D) We could always dial back our savings in the short term if needed.
If you are not risk averse, you can bypass this step.
4. Max Roth IRA
Once you have fully funded your emergency fund and are receiving the full employer match on your retirement account, it’s time to contribute to your Roth IRA, or similar. In this case, you pay all taxes currently, but then pay no taxes when you withdraw in retirement (after age 59 ½). This account is so powerful, the government limits you to $6,000 as of 2021 ($7,000 if you’re over 50). You can spread the contributions throughout the year, or you can contribute a big chunk before Tax Day of the following year. My husband and I do the latter, contributing $12,000 in April and investing in index funds. Note that once you’ve had an IRA for 5 years, you can withdraw your principal (the amount you’ve put in) with no penalties. I do not suggest doing this, but it’s relevant if you’re unsure about contributing.
Note that if we had access to a Health Savings Account (HSA), we would suggest maxing that here as well.
5. Real Estate: Save for Down Payment(s)
My husband and I are passionate about real estate. If you are also passionate about real estate, your next investment step after you’ve maxed your emergency fund, 401k match, and Roth IRA is to start saving for a down payment. You only need to put 3.5% down to buy a 1–4-unit property if you make that property your primary residence. We recommend a small multi-unit as your first property, and we recommend you move into one unit and rent the other unit(s) out, which is called house hacking. If you can save up 20%, you will save money by not paying mortgage insurance, but 3.5% really is all you need.
If you find you are super-duper passionate about real estate and want to save more to invest in it, you can stop here and keep saving for real estate investments, like a more traditional primary or additional rentals. We stayed here until we owned 2 properties. We moved up to the next step because we happen to also believe in the stock market, so our model suggests moving to the next step from here.
6. Max 401k/403b completely
Once you have your foundation in place and you own a primary residence, it’s time to circle back around to your 401k (or similar) and max it out. The limits as of 2021 are $19,500 for everyone under 50 and $26,000 for everyone 55 and up. If you add your 401k and Roth IRA contributions together, that’s $25,500 for a single person and $51,000 for married couples under 50. This is a lot of money. Not everyone can do this. In the next few years, we will stop maxing our 401k’s out because we will have enough principal saved to take care of our retirement after age 59 ½.
7. Contribute to a Taxable Brokerage and/or More Real Estate Savings
If you have gotten this far and still have money to save, congratulations are in order because not only do you make a lot of money, but you also have more discipline than the vast majority of the population. Kudos! With our 1-month emergency fund in place, retirement accounts maxed, house hack primary residence owned and one rental property, Aric and I moved on to saving $1000/month in a taxable brokerage and $1000/month towards real estate. We purchased a third property one we reached this step (with a boost from a cash-out re-fi). We’re on the path to buying one more property, then building a “war chest” to prepare us for early retirement.
Remember that personal finance is very personal. This savings model is what works for us for now. We suggest finding a savings method that works for you, and hopefully this one gave you some ideas. As long as you’re consistently saving 10-25% of your income, you are doing brilliantly and should have a comfortable retirement.