Last time, we covered cutting down your expenses and having proper insurance coverage. Those are the preliminary steps; we’re just getting started with controlling our expenses. Now is when things start to get interesting!
Step 3: Fund Your 401(k) or Equivalent Plan Up to the Employer Match
This one is pretty basic; if your employer offers to match the contribution to your 401(k) (or one of the 401(k)’s kissing cousins, 403(b)s and Thrift Savings Plans (TSPs)), you should jump at it. Taking advantage of such an offer is usually (although, not always) a good idea. Turning down a match is equivalent to giving up free money.
Don’t believe me? Let’s run through a quick example. Your employer offers a fifty percent match on your money up to 5% of your salary; that is, for every dollar you contribute to the plan, the company adds fifty cents, at least until you are contributing 5% of your gross salary. So, if your yearly gross income is $30,000, you can add up to $1,500 to your account, and your company will add in $750, for a total investment of $2,250. (Plus, because you contribute pretax dollars to a 401(k), the decrease in your spending money is going to less than the full $1500 you added.) Look, you have made a profit of 50% on your money, before any investment return.
You can even stay ahead if your investments fall. Let’s say that we have a repeat of 2008 after you’ve made this contribution; your chosen investment(s) decline in value by 30%. But, because of the added money in your 401(k) from your company, your investment is still at $1575, a profit of 5% even in a horrible market.
In short, a company match is a wonderful aid to your investment goals, and the return on investment with a good match is hard to beat. It should be one of your first financial goals.
Step 4: Create a Small Emergency Fund
Before we get into the heavy lifting of debt repayment, it’s useful to have a small emergency fund available. It will provide a psychological boost to you, knowing that you have extra money set aside for any unexpected events. You can also avoid falling back into old habits and breaking out your credit cards for any emergency you encounter.
The size of such a ‘starter’ emergency fund is a matter of much debate. I think enough to cover one month of your regular expenses should be enough for most of the minor emergencies you are likely to encounter, but that’s just my opinion. A better way to decide how big to make this emergency fund is to sit down and consider what could go wrong in your life over the next few months. Are any of your appliances on their last legs? Does your car need serious work? Is your family prone to catching colds and missing work? Use the answers to these and other questions about your current situation to come up with a figure that should cover the foreseeable ’emergencies’ you’re likely to face in the next few months, and regularly reconsider just how much you need, adjusting the size of your fund accordingly.
Once you know how much to have available, decide where to keep your emergency fund; somewhere safe, secure, preferably with a decent interest rate, and accessible if the need arises. A good money market mutual fund or online savings account should do nicely. Just make sure you only withdraw the money for a genuine emergency, and not for random spending.
Now things are starting to get tougher; hopefully, you’ve been able to make it through these first few steps without any serious problems. The next two steps are where we really begin to make progress; stay tuned!