Prioritizing your investments and debt is all about trying to maximize the return on your dollar. When I got my first job out of college, I made the mistake of prioritizing the repayment of my student loans, which was approximately at 6% interest, over maxing out my TSP (the long-term average return of the stock market is 8-10%, so if I had prioritized funding my TSP over paying off my student loan, I would have gotten a better return on my money).
Here’s how you should prioritize your investment and debt to get the best return on your money.
1. Build an emergency fund (3-6 months of living expenses)
Build a cash cushion so you don’t have to rely on high-interest debt like credit cards to keep you afloat during emergencies.
2. Contribute to 401(k)/403(b)/TSP up to the match
This is the highest return you can get on your money, so take advantage of it. A 100% match means the amount of your contribution is automatically doubled without any risk. You won’t find a better investment anywhere else, even if the fees on the retirement account are high.
3. Pay high-interest debt (8%+) using the debt avalanche or debt snowball approach (e.g. credit card debt)
There is no point trying to chase investment returns (which isn’t certain) if you have high-interest debt (which IS certain). Work on paying off your high-interest debt first.
4. Max out Health Savings Account (HSA), if you have one
HSAs are completely tax-free when used for medical expenses. At 65, it behaves almost like a Traditional IRA.
5. Max out IRA (Roth or Traditional depending on your personal situation)
If your marginal tax rate now is higher than your estimated marginal tax rate at retirement, then the traditional account is the better option; if it is lower, then the Roth account is the better option.
6. Max out 401(k)/403(b)/TSP
If the fees in the 401(k)/403(b) are low, then max out 401(k)/403(b) before maxing out IRA. TSPs should be maxed before IRAs since the fees (0.038%) are very low.
7. Fund Mega Backdoor Roth, if your company offers it
This strategy could allow you to contribute an additional $35,000/yr to your Roth IRA.
8. Pay moderate-interest (6%+) debt
Now focus on paying off moderate-interest debt.
9. Fund children’s college education, if desired
Open and fund a 529 Plan.
10. Fund taxable account or other asset-producing investments (e.g. rental property)
Fund short-term goals (e.g. down payment for home, replacement car, wedding, pay-off mortgage, vacation, etc.)
Anything here surprise you?
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