In our fast-paced, consumer-driven world, it's easy to find ourselves splurging for spontaneous purchases. With targeted ads on every website we visit, marketing emails filling our inboxes, and more ads on the screens we watch, separating true financial priorities from impulse purchases is getting harder and harder. Even for people trying to do the right thing with their hard-earned dollars, like saving for retirement, a child's education, or that important financial goal, it is increasingly more challenging and stressful figuring out where to allocate those dollars.
We've seen how easy it is to overspend when too much cash is left sitting in a checking account. As we enter bonus season, I wanted to repost this blog.
Here is our definitive list and a helpful flow chart to help you figure out where extra dollars or your next dollar should go. We hope this enables you to stick to your plan and build financial security and freedom.
The top priority should be to focus on financial security for yourself and your loved ones.
- Create or Update Your Estate Planning Documents - A plan to protect your loved ones in the event of your passing lands at the top of our list, especially for parents of minor children. With extremely rare exceptions, every independent adult should have a basic estate plan. Download our eBook to learn more about estate planning.
- Make sure that you are adequately insured. Don't become the next heart-wrenching 20/20 segment because your family was left destitute after you died or were disabled without appropriate insurance for catastrophic events. We want to stress the term adequately. Surprisingly, most insurance needs, especially life insurance, can be sufficiently covered with affordable policies that are less expensive and simple than the bell-and-whistle products often recommended by insurance agents.
- Pay off any high-interest consumer debt. It is tough to build financial security when your liabilities are dragging you down. With interest rates at decade highs, these debts are increasingly costly. Pay down your debt so that you can start buying assets to help you build your wealth.
- Build at least a month of emergency savings. Savings is the first line of defense against consumer debt and the first step to financial freedom. Yes, of course, you want 3-6 months of emergency savings, but if you don't start with one month because the following priorities are too good to put off.
If you have already established the foundations of financial security, your next dollar should be committed to growth!
- Earn free money with your company's 401k match. Many companies offer employees a matching contribution to incentivize savings. Make sure you contribute at least enough to take advantage of that match and get all that free money you will spend in retirement.
- Max Out Your Health Savings Account. Health Savings accounts are the only triple-tax-free account available to taxpayers in the US. Healthcare is also one of the most expensive line items for people in retirement. Use your extra dollars to lower your taxable income and build assets to address those future healthcare costs.
- Contribute to a 529. Education should not take precedence over retirement, and only contributing the matched amount to your 401k will likely not secure your future retirement. But for parents who have checked off items one through six, it's time to consider opening 529 accounts for children you intend to help pay for education. Contribute what you can and invite loving relatives to do the same. The SECURE Act 2.0, passed in 2023, includes provisions allowing 529 to Roth conversions. This new law makes 529 accounts a lot more dynamic for financial planning.
- Create a Roth Strategy to supplement your 401k. Nothing's better than free money, but tax-free money comes close. Utilizing a Roth IRA fills up a bucket of money that will never be taxed (as long as you wait until 59.5 to distribute gains). And, if you have an emergency that depletes your emergency funds, you can take out your contributions at any age, for any reason, without tax or penalty. You cannot contribute directly to a Roth IRA if your income exceeds the Roth limits. But you can work with an advisor to implement a Backdoor Roth strategy.
- Come back to maximize your 401k. If you have checked off all the items on this list and still have extra dollars, you probably have a fairly high income. By maxing out your 401k, you set yourself up for retirement success and lower your taxable income. In 2023 401k contribution limits are $22,500. For investors over 50, catch-up contributions push the total contribution limit to $30,000.
- Excersize NQSO/ISOs. For employees with stock options that have strike prices below the market price, exercising options is a great way to buy something at a discount with a very high probability of profit. While we all know stocks are volatile assets, and there is no guarantee of profit, harvesting the value from stock options is an excellent opportunity to build wealth.
- Build your taxable investment portfolio. You are doing a great job if you have checked everything off of this list. With appropriate emergency savings, you are protected for the short term. You are well-positioned for retirement with fully funded 401k, and Roth IRA accounts. Building a taxable investment portfolio creates wealth to support medium-term financial goals like purchasing a house, supplemental education funds, or annual vacations. It can also fund aspirational goals, like a beach house or early retirement.
We hope this guide helps you prioritize your savings and answer the question, "What should I do with the extra cash in my checking account?" If you want more information about where to put your next dollar, download this helpful flow chart.