Where Your Money Should Go First, In Six Steps

For about eight months after my first real job I did this in an order that cost me money, and I can tell you roughly how much. I was putting $200 a month into a brokerage account, feeling responsible about it, while carrying $4,100 on a credit card at 22%.

The card cost me about $900 a year in interest. The brokerage account made about $190 in the same stretch.

So I paid $900 to earn $190.

Backwards.

Nobody corrected me, because the order you put money in is not something people talk about. They talk about whether to buy a house and whether the market is expensive, and they skip the part that decides almost everything, which is which dollar you spend first.

There is an order. It is not clever and it is not a secret. It is arithmetic about which dollar buys the most, and here is mine on one page.

The six steps

1. 01Contribute enough to your 401k to get the entire employer match.
2. 02Build one month of expenses in cash.
3. 03Clear every debt charging more than about 8%.
4. 04Fill your tax advantaged accounts.
5. 05Finish the emergency fund, three to six months.
6. 06Taxable brokerage, and the rest of your life.

Step one: the match, and why nothing beats it

Say your employer puts in 50 cents for every dollar you contribute, up to 6% of your salary. That is the most common shape I have run into, though the exact numbers vary by plan.

On $80,000 a year, 6% is $4,800 out of your paychecks and $2,400 in from them. $2,400 on top of $4,800 is a 50% return, credited before the money has been invested in a single thing.

Nothing else on this list returns 50%. Paying off a 22% card returns 22%. A broad stock index has historically averaged somewhere around 10% a year before inflation over long stretches, and any single year can be down 20%.

The match is the only line in your finances where the return is written into a contract.

One caveat, and it is a real one. The match is often subject to a vesting schedule, meaning it is not fully yours until you have been there a certain number of years. Your own contributions are yours from day one regardless. Go find out which schedule your plan uses before you assume the $2,400 is banked.

Step two: one month of cash, before the debt

The transmission goes on a Tuesday. The shop wants $2,400 before they hand the keys back, and you need the car to get to the job that produces every other number in this article.

If that $2,400 has to go on a card at 22% and it takes you a year to clear it, it costs about $300 in interest. Worse, it undoes whatever progress you just spent four months making, and the psychological version of that is what makes people quit.

One month is enough here. Not three, not six. If your monthly expenses are $3,800, you are looking for $3,800 sitting somewhere boring, and then you move on to step three.

Step three: anything above about 8%

Paying down a balance at 22% is a guaranteed 22% return, tax free, with no market risk and no waiting. $6,000 on a card at 22% costs $1,320 a year. Clear it and you have permanently created $1,320 of annual cash flow.

There is no investment I can name that offers 22% guaranteed. There is no investment anybody can name that offers it.

The 8% line is where I draw it and here is the defence. If a broad stock index returns something like 10% a year before inflation over long periods, and you will pay tax on those gains eventually, the honest after tax expected return sits below that. Above roughly 8%, paying the debt wins on arithmetic and wins with certainty, which is a second thing it has going for it.

Below 8% it gets genuinely arguable. A mortgage at 4% I would not rush. A student loan at 7% I would treat as a coin flip and pay off anyway, because I sleep better, and how you sleep is a legitimate input.

Step four: fill the tax advantaged space

A tax advantaged account is one the government treats differently from a normal brokerage account, either by letting you deduct what goes in or by letting the growth come out untaxed. A 401k, an IRA and a health savings account all qualify.

The reason this beats finishing your emergency fund is a rule most people miss: the space expires. Say the annual 401k limit that year is $23,000 and you contributed $4,800 to capture the match. You left about $18,200 of space on the table, and on January 1 it is gone. You cannot go back for it, ever.

Cash you can rebuild in any month you like. Contribution room you cannot.

The size of the benefit is easy to compute. On a 22% marginal rate, putting $10,000 into a traditional 401k lowers your taxable income by $10,000, so this year's federal tax bill drops by about $2,200. You pay that tax later, when you withdraw, which is a different question I would rather handle separately.

If you have access to a health savings account, the account attached to a high deductible health plan, it belongs in this step and arguably at the top of it. It is the only account I know of where the money goes in untaxed, grows untaxed, and comes out untaxed when it is spent on medical care. Three exemptions in one wrapper.

Step five: finish the emergency fund

Three to six months of expenses, on top of the one month you built in step two. At $4,000 a month that is $12,000 for three months and $24,000 for six.

Where it sits matters more than people expect. $24,000 in a savings account paying 4% earns $960 a year. The same $24,000 in an account paying 0.01%, which is what a lot of big bank savings accounts pay, earns $2.40.

Same money, same risk, same access. $958 of difference for filling in a form once.

Here is the honest caveat on the ordering. If your income is lumpy, if you are on commission, if your industry is laying people off, flip steps four and five. Put the cash first. I would, and the tax space you give up is the price of not being forced to sell something at a bad moment.

Step six: the taxable brokerage account

No contribution limit, no withdrawal penalty, no age rules. You pay tax on dividends as you go and on gains when you sell, and that is the whole trade.

This is the account almost everybody opens first, because it is the one with the app and the marketing budget. It belongs sixth.

Three exceptions I would actually make

A 0% promotional balance is not debt at the rate on the card, it is debt at 0% until a date. Pay the minimum, put the rest of the money to work, and set a calendar alert for a month before the promotional period ends. Then pay it off in full on that day, because the rate that replaces 0% is usually somewhere north of 20% and it can apply retroactively depending on the offer.

A pension, if you somehow have one, changes step four. Guaranteed income in retirement raises the tax rate you will face when you withdraw, which tilts the Roth and traditional decision, and it lowers the amount of cash you need to hold against a long retirement.

A raise is the cheapest place to find money for any of this. You have already proved you can live on the old number, so routing half of every raise into step four is painless in a way that cutting existing spending never is. I do half, automatically, on the day the new salary starts.

What the order actually buys you

Run the first three steps on an $80,000 salary with a $6,000 card balance at 22% and it looks like this. The match adds $2,400. Clearing the card frees $1,320 a year. One month of cash costs you nothing and prevents the next $2,400 repair from restarting the whole cycle.

$3,720 a year, from sequencing alone, before you have picked a single investment or earned a raise.

That is why I care about the order more than I care about which fund anybody buys.

Write your own version on paper tonight. Six lines, your salary, your match formula, your actual interest rates next to each debt. Mine took four minutes and it is the only financial document I have never had to redo.

Then go find out what your 401k is doing with the money once it gets there. Mine was sitting in a fund charging 0.71% a year and I had no idea for four years.