In this short post I will try to summarize what I would do to start building wealth if I were just starting out. Your circumstances may be different, so proceed with caution and don’t take this as gospel.
Here we go:
First, if your employer offers a 401K plan with a match, I would contribute up to the maximum amount matched. Some companies match your contribution dollar for dollar. Others match 50%. Either way, that’s an instant 100% or 50% return on your money. You won’t get that kind of return anywhere else (that I know). Plus, your money will grow tax free until you’re allowed to withdraw it.
Once you’ve maximized your 401K match, the next step is to eliminate all credit card debt. Credit card interest is a rip-off (20% or more per year in most cases). I don’t know of any safe investment that pays that much. Paying off your credit card debt is like getting a double digit return on your money. Once your balance is paid off, make it a habit to pay your credit card bill in full every month.
After your credit card debt has been obliterated, it’s time to build an emergency fund. An emergency fund is designed to protect you against unexpected events like the loss of a job, car and home repairs, medical bills, etc. You should budget at least a full year of living expenses, plus a couple thousand dollars for car repairs and another couple thousand for home repairs. Also, add any other expense you anticipate in the next 12 to 24 months: a trip, a wedding, a course, etc. Once you take everything into account, your emergency fund may need to be several tens of thousands of dollars strong. Granted, it’s not easy to save that much, but doing so will give you piece of mind to engage in other types of investment.
Once your emergency stash has been funded, it’s time to look at your 401K plan again. Go ahead and invest up to the maximum allowed beyond your company match. Even though you’re not getting a match your money will still grow tax free. The only drawback is that it will be tied up for a long time, but since you’ve already built an emergency fund you shouldn’t be concerned.
If you still have money left, open a Roth IRA, which works like a 401K that you can open yourself, without going through your employer. Since a Roth IRA is funded with after tax dollars, not only will your contributions grow tax free, but you will also be able to withdraw your money tax free once you reach the required age.
If you’ve done everything so far and still have money left, you can now open a brokerage account. Your brokerage account is a place to park your money until you decide to invest it. By opening a brokerage account with any of the reputable discount brokerage firms, you will be able to buy and sell stocks and mutual funds online or by phone.
My personal preference is to start with index funds (funds that mimic the performance of a market index like the S&P500), since they have the lowest fees and usually better returns than funds managed by so called experts. Then, I would purchase stocks of good, solid companies during market dips or when the stock is cheap. I prefer to hold my investments for the long run, instead of trying to time the market by constantly buying and selling.
With this set up, plus good money habits, you should be well on your way to a comfortable financial position.
Remember that these are just a few tips, and that there are plenty of good books in the personal finance space that you can read. Two that I recommend are: The Millionaire Next Door, by William D. Danko, to start developing good money habits, and I Will Teach You To Be Rich, by Ramit Sethi, for actionable tips on setting up your financial accounts and designing the right systems to manage your money.