The age old question: what to do with money? Any money at all. It has stumped millions of people over thousands of years, and will continue to do so. Allow me to present you with the six personal finance steps I take with my money.

Let’s say this is the first money-related blog post you’ve ever stumbled upon in your life. Somehow, due to my excellent SEO optimization (I don’t even know what that means), you’ve landed here to figure out the ultimate question. What should I do with my money?

There’s good and bad advice to be had from many of your popular Dave Ramsey/Suze Orman types. Then there’s good and relatable advice from the JL Collins and Mr. Money Mustache corner of the web. I’m not going to spend a ton of time regurgitating topics that are already a Google away. At least not on purpose. But this one is important enough that I’ll give you the blueprint that I followed as I began to educate myself about money. Do with it what you will.

What To Do With Money

It’s a great question to be able to ask. It means that there is an element of choice involved. We’ve paid for rent and food and all the other absolute necessities that we require of our money, and now we’re figuring out what to do with the rest. That’s a good place to start. Believe it or not, it already puts you among some of the richest people to ever walk the Earth.

Most people think of using money in two ways: spending and saving. The first part is easy, and the second part is even easier. At least it is once you automate it. There are two problems with thinking about your money in these two vague terms. The first is that the spending comes first and is followed by the saving. It should be the other way around. By setting up automatic investments (a company 401k is a common example) you ensure that you are “paying yourself first” as they say. That takes care of that problem. The second issue is that “saving” is too simplistic a term for what we want to do with our money. We want to save ourselves from spending money, yes. But more importantly, we want those savings to grow and begin to work for us.

For the purposes of explanation, let’s pretend that you just came into a $40,000 inheritance. Money that you didn’t have yesterday. People often wonder what the hell to do with a lump sum of money, after all the basic needs have been met. More often than not, spending is way easier than saving in those instances. But whether it’s a lump sump, or you just happen to have an extra $100 after your regular monthly expenses, the logic will remain the same.

So what exactly do we do with this money?

Here are the six steps I would take with my $40,000. Know that the first four are fairly interchangeable depending on your situation. Then again, that’s exactly the kind of noncommittal nonsense you’re sick of hearing. You just want somebody to tell you what to do with this fictional dollar amount. So bet it. I’ll list these steps below, and then go into further detail about why we settled on this particular order of things. 

Six Personal Finance Steps I Take With My Money

Simple enough, right? Save, invest, invest, settle your affairs, invest some more, and then invest some more. Now time for the gory details.

1. Emergency Fund

($1,000; $39,000 inheritance remains)

Before we do anything, let’s get a little bit of cash stashed away in a readily accessible account for life’s unexpected events, of which there will be several. Let me think of an example, hm, I don’t know, maybe a global pandemic?! If you’re a single weirdo like me, let’s just start the bidding at $1,000, which is a very low threshold compared to the standard recommendations. If you have a family, let’s account for at least $1,000 per person. We can always pad this number further down the line in between later steps.

Common advice regarding the amount of money you should have in an emergency fund follows similar guidelines to buying a wedding ring. Some people say 3-6 months salary (or living expenses), some say 6-9 months, and some say a fairly low amount like I do. Incidentally, this figure frequently corresponds with whether or not you have purchased a wedding ring in your life. If you don’t have a family to support, you can get by with a small emergency fund. The concept is fairly similar to life insurance. Have kids? Better make sure they’re taken care of if something happens to you. Single weirdo? Don’t worry about it so much.

Now, where should you put your Emergency Fund? There are various online banks that typically 1-2%. I use Ally Bank, but they are all pretty much the same. This is a low return on investment, but it is better than the 0.01% in your regular bank account. The important thing is having ready access to it, so I keep $1,000 in a savings account for that sweet 1/100 of a percent, and then a couple thousand in checking for accessibility purposes. Online banks typically take 2-3 days to access your money, whereas a checking account is instantaneous. At such low rates, I’m reconsidering what to do with my own emergency savings.

Ultimately, this number depends on your comfort level. Shit happens and a small emergency fund can backfire. My personal viewpoint is that the bigger risk is in not having enough money doing it’s job for you in the stock market, outpacing inflation and then some. But every situation is different, so read about what other people do and then determine what’s best for you.

2. 401k match

($6,000 to receive full company match; $33,000 inheritance remains)

Most employers offer a company 401k plan. A decent percentage of them offer some sort of matching contributions to the money you sock away. Matching contributions are the closest we’ll get to those fat pensions of yesteryear. If your company doesn’t offer a 401k match, bug the hell out of your HR folks—politely, of course—and hope that in time they will. If you don’t get a match, you can skip this step for now and return to your 401k in a bit, but it will still be worth investing in this vehicle.

For those with a match, this is literally free money. It’d be wrong not to take it. Think of it as simply part of the regular salary or compensation that your employer owes to you for goods exchanged—so long as you claim it.

Now let’s throw some fake numbers around. Say your company matches up to two grand as long as you contribute six grand to your 401k plan. By stashing away $6,000, you get a $2,000 bonus. What a deal! This is still very much your money and is now working for you in the stock market. This money is taken out pre-tax (tax deferred), so depending on which state you live in, you’d likely only see about $4,000 of that $6,000 up front anyway. Since it is tax deferred, you won’t be taxed on that money until you withdraw it from your 401k at some point in the distant future, in which case you’ll hopefully be retired and in an even lower tax bracket than you were when you earned the income.

Company 401k plans are very user-friendly. They typically come with some free guidance in the form of your HR or Payroll department. They transfer money automatically from your paycheck to your investment account. It couldn’t be easier. Take advantage.

Back to our fictional lump sum. I’m cheating a little here because this wouldn’t be something that you could contribute in one fell swoop, but rather in smaller automatic increments over time. But you get the point.

An important distinction if you’re new to all of this stuff: the 401k is simply the vehicile that we’ll strap our investment into. You’ll need to pick from the list of mutual funds available to you from your 401k provider.

This is that confusing list of growth, small cap, mid-cap, and other terms you’ve never heard before in your life. We won’t get too in the weeds on this, other than to again recommend JL Collins. Like him, I’m all-in on low cost funds that track a particular index like the S&P 500. I’ll talk a little bit about those in Step 6.

3. Roth IRA

($6,000 max contribution; $27,000 inheritance remains)

At this point, we’re getting our company match on the 401k, which is great. Can we keep throwing money at that account beyond what our company will match? Sure, that’s fine and keeps things simple. That account is already set up and automated and the whole nine yards. But better yet, we could take some of our money that has already been taxed (earned, inherited or otherwise), and set up a Roth IRA.

Like the twice aforementioned JL Collins and several others in the personal finance space, I am strongly preferential to Vanguard due to their low-cost index funds. So let’s set up a Vanguard Roth IRA account and contribute the full $6,000 annual contribution to that bad boy. More than likely, you will dollar-cost average this amount similar to your 401k, rather than throwing in the full lump sum. However, there is some mathematical advantage to throwing all six grand in at once at the very first opportunity available to you (Jan. 1 of each year). The longer you’re in the stock market, the better off you’ll be. Even with this knowledge, though, I’m generally more comfortable from a psychological standpoint with dollar cost averaging over the first half of any given year.

Why is the Roth IRA preferential to a 401k? Mainly due to the fact that you’ve already paid taxes on this money, so you won’t be paying them again on the way out. That also applies to the money this invested chunk earns for you. The catch here is that you won’t be able to touch the earnings on this money without penalty until after you’re 59 ½, so it truly is a retirement account. But what sometimes gets lost is that you are able to take out the amount you’ve contributed at any point if you absolutely need to. Just because you can doesn’t mean you should, but know that you can. The hardest part is putting the money away in the first place, but if shit hits the fan and that $1,000 emergency fund doesn’t cover you, this can be used as a last-ditch emergency fund of sorts.

4. Pay down debts

($5,000 personal debt; $22,000 inheritance remains)

Step 4 could very well be ahead of Step 3, and probably should be. But I put it below to atone for my own past sins. For me, this was effectively Step 2 in my journey, strictly due to a lack of knowledge of any steps beyond that. While getting out of debt is never a bad thing, there is a certain opportunity cost in paying down lower-interest debts (especially student loans at rates below five percent) and missing out on the annual returns of the stock market (generally quoted at anywhere from 7-10 percent).

If you have debts with an interest rate exceeding those annual expected market returns, you’d do well to bump this up to the second step yourself. Most credit cards charge upwards of 15-20 percent in interest, and you’ll want to treat that with much more urgency than the 4 percent mortgage or 6 percent student loan.

I talk a big game, but even knowing what I know now I’d still have a hard time letting the cloud of debt hover over me as I entered my 30s. From a purely mathematical standpoint, annual market returns of 7-10 percent are going to outpace an interest rate of anything less than that. But aside from the emotional boost of becoming debt free—which you really can’t put a price on—there is one additional caveat. The 7-10 percent returns mentioned are what the market returns on average. This means they may be even better, or far worse, during the amount of time you’re paying down your debt at a fixed rate. In my case, the market returns were far better, hence my regret at not contributing to investment accounts during this time.

Realistically, you’ll combine steps 3 & 4 to cover your minimum monthly debt payments while putting away whatever else you can in a Roth IRA up to the $6,000 limit. There are several different schools of thought in how to pay off this debt. I went with more of a Debt Avalanche over the Debt Snowball, but there’s no wrong answer. The only wrong answer is staying in debt.

Back to our hypothetical example. Let’s give you $5,000 of personal debt, which I realize doesn’t even begin to account for the current student loan crises, but is a nice round number we can knock out and continue on our journey.

5. Max out your 401k

($13,000 remaining contribution to reach 19,000 max; $9,000 inheritance remains)

Things are starting to get easy at this point. You’re debt free, you’ve got some money invested, life is good. Return to that 401k and max out those tax deferred benefits. Depending on your income tax bracket, contributing nearly 20 grand to your 401k may help you dip below an increased tax rate because your contributions lower your adjusted gross income (AGI).

In our scenario, while this $13,000 won’t be matched by your employer like the first $6,000 was, it still has its advantages. This money is benefiting from the beauty of compound interest while helping us duck Uncle Sam for, ideally, the remainder of our working life. The more you are able to stash away and the longer you are able to keep it stashed, the better off you’ll be.  

A quick aside about your emergency fund in the all-important Step 1. Either before or after maxing out your 401k, feel free to head back to Step 1 and give yourself a little more cushion in the emergency fund. I keep roughly $20-30k between an online savings bank and my checking account. Depending on who you ask, this is either way too much or way too little. Again, the cop out answer is that it depends on your situation. Go with whatever makes you comfortable.

6. Brokerage account

($9,000, entirety of remaining inheritance).

And now for the final boss of our six-step money strategy, and one that few investors even get to in their lifetimes. It’s time to open a brokerage account.

The rise of Robinhood accounts and pandemic day-traders means it’s likely some of you have already dipped your toe in these waters. It’s also likely that some of our steps were skipped along the way. Nothing wrong with that. Actively trading stocks is a great way to learn, but it can also be an expensive lesson. I earned my PhD from Penny Stock University, and it was just as costly as any college education you’ll find.

While Robinhood is an option, we’re going to return to our Vanguard sanctuary. We already have a Roth IRA over there, so let’s go ahead and open up a brokerage account with them.

Instead of picking individual stocks, we’ll go back to the boring but effective low cost index fund, VTSAX. Vanguard’s total stock market fund gives a piece of every stock on the U.S. market, or about 3,000 companies. There are other similar indexes, such as an S&P 500 index fund (the 500 largest companies in the United States), but we might as well diversify even further with an additional 2,500 companies in our investment portfolio. 

Can you pick individual stocks? Sure, you can try. You might even come out ahead in the short term. But over time, it is incredibly difficult for individual investors to outperform the market. Hell, it’s incredibly difficult for professional investors to do so. Owning the entire stock market gives us protection from putting all our eggs into one basket. Plus, why pick a handful of companies and hope we chose the right ones when we can get a piece of all of the fastest growing and best performing companies in the world. Amazon, Apple, Microsoft. You name it, we own it.

Just remember, we want to buy this fund and hang on to it for a period of 20-40 years or longer. Constantly buying and selling individual stocks within a brokerage account means that we’ll have to pay taxes on those capital gains. This digs even further into our overall returns. Of course, you’ll pay taxes on any brokerage gains 40 years from now, but you’re giving that money a chance to compound and grow for a long period of time before it’s eventually taxed. If we did this right, you’ll be in a much lower tax bracket as a retiree.

Summary

For a personal finance blog, this is a fairly rudimentary overview. Some of the more well-known personal finance bloggers out there are well-known for a reason. Simply following JL Collins’ stock series will teach you all you need to know. But for something simple, those are the six personal finance steps I take with my money.

Having said all of that, the real answer to what you should do with your money is: whatever the hell you want. It’s your money! All guidelines out there are just that: guidelines. You can deviate from my plan, or any other, as you see fit. Even if you follow my steps, life circumstances could necessitate an audible. The simple act of having a plan puts you way ahead of the game.