Order of Operations - Personal Finance
4th April 2008
In math, we have an order of operations (inside parens first, multiplication comes before addition, etc.). There is also an order of operations in personal finance. Each person has to decide what to do first for him- or herself, but there is definitely a preferred order:
1. Get minimum payments made. Scrimp and save until you can cover all your obligations. When you have extra:
2. Get your $1000 emergency fund. You should still be covering all your obligations. Use this emergency fund only in the case of emergencies. Once you are covering your obligations and have a $1000 emergency fund in place, you should:
3. Pay down the smallest or highest-interest credit card. Pay them off one by one. Different people like to pay off credit cards in different orders, but the point is to do it. Once you have all your obligations covered, you have a $1000 emergency fund, and you’ve paid off all your credit cards, you should:
4. Get a good-sized emergency fund. This should cover 3-6 months of living expenses, depending upon how income-diverse and/or risk-taking you are. Once you have all your credit cards paid off and a good-sized emergency fund, you should:
5. Pay off all other consumer debt. This includes car loans, student loans, etc. Student loans should come last because of the benefits they have (low interest rate, etc). Once you’ve done all this, the only bill you have left every month are your utilities and your food/consumer goods you need each month. Once you’ve paid off all your consumer debt and have a good emergency fund and still have extra money left over each month, you should:
6. Invest in your 401(k) up until the employer match. Employer matches are free money. Do it. Once you’ve done this and you still have extra left over, you should:
7. Invest in an IRA. Choose Roth or Traditional according to your income expectations for retirement (if you expect a huge income in retirement, you don’t want to be taxed in retirement by taking out a traditional IRA, or vice-versa - if you expect no income in retirement, a traditional being taxed is not going to be a huge chunk. If you will have extra income in retirement, you should get a Roth. If you will not have any additional income in retirement, you should get a traditional). If, after all this, you still have money left over, you should do one of many things:
a. Save for your children’s college
b. Save up cash to purchase your next vehicle
c. Invest more money in mutual funds
d. Pay off your house
That is the traditional order to do things in (a., b., c., and d. are in good order as well). Did I miss anything?
My particular order of operations is off. We’re paying off our house before topping off retirement funds. It’s a bad deal, but it’s what DH wants. The house will be paid off in 12 or 13 payments, so hopefully I can catch up (by paying the full limits on both IRAs and 401(k)s after house payoff).
What order of operations are you following? Does it mirror this one? Which step are you on?
April 4th, 2008 at 5:23 pm
Hi! I’m new to the blog and this is my first time posting but I’d like to give my 2 cents.
I tend to work on some of these things concurrently. For instance, I’ve fully met my company’s 401k during the whole process because I’m in my 20s and I know that saving now is critical. I think that the compound interest you can start to accrue in your 20s, as opposed to a few years down the road when all consumer debt is paid off, is irreplaceable. The same goes for an IRA. As long as all credit card debt is paid off, shoveling extra money toward an IRA is a good choice if you’re younger.
April 4th, 2008 at 9:22 pm
I am not quite sure but I think my order is in reverse.
I don’t have any debt to speak of other than a short 5 month payment plan on my new laptop.
So in effect, my order is actually funding my 403b (since it is taken out of my paycheck before I see it) which is matched a little bit, funding my emergency fund which is targeted at 3K this year (but projected to reach 4K),
And then finally, if not the last, funding my REI investment account for my first REI property.
April 6th, 2008 at 2:36 pm
[…] I enjoyed Dollar Frugal’s use of math’s Order of Operations - Personal Finance. She certainly provided us with a terrific perspective on handling your personal finance, especially debt. Since I only have a laptop balance to pay off and already contribute regularly to my retirement portfolio, my own order of operations is a little more advanced. […]
April 6th, 2008 at 7:59 pm
@Amy - you’re right. You should fund your retirement as early as possible. Each person has a different order. But you cannot go back in time and invest in your 401(k). I guess the best thing to do is not get into consumer debt, right? Then I wouldn’t have had to deal with any of this!
April 9th, 2008 at 10:01 am
[…] Brooke presents Order of Operations - Personal Finance posted at Dollar Frugal. […]
April 14th, 2008 at 9:51 pm
[…] Order of Operations - Personal Finance In math, we have an order of operations (inside parens first, multiplication comes before addition, etc.). There is also an order of operations in personal finance. Each person has to decide what to do first for him- or herself, but there is definitely a preferred order: 1. Get minimum payments made. Scrimp and save until you can cover all your obligations. When you have extra: 2. Get your $1000 emergency fund. You should still be covering all your obligations. Use this emergency fund only in the case of emergencies. Once you are covering your obligations and have a $1000 emergency fund in place, you should: 3. Pay down the smallest or highest-interest credit card. Pay them off one by one. Different people like to pay off credit cards in different orders, but the point is to do it. Once you have all your obligations covered, you have a $1000 emergency fund, and you’ve paid off all your credit cards, you should: 4. Get a good-sized emergency fund. This should cover 3-6 months of living expenses, depending upon how income-diverse and/or risk-taking you are. Once you have all your credit cards paid off and a good-sized emergency fund, you should: 5. Pay off all other consumer debt. This includes car loans, student loans, etc. Student loans should come last because of the benefits they have (low interest rate, etc). Once you’ve done all this, the only bill you have left every month are your utilities and your food/consumer goods you need each month. Once you’ve paid off all your consumer debt and have a good emergency fund and still have extra money left over each month, you should: 6. Invest in your 401(k) up until the employer match. Employer matches are free money. Do it. Once you’ve done this and you still have extra left over, you should: 7. Invest in an IRA. Choose Roth or Traditional according to your income expectations for retirement (if you expect a huge income in retirement, you don’t want to be taxed in retirement by taking out a traditional IRA, or vice-versa - if you expect no income in retirement, a traditional being taxed is not going to be a huge chunk. If you will have extra income in retirement, you should get a Roth. If you will not have any additional income in retirement, you should get a traditional). If, after all this, you still have money left over, you should do one of many things: a. Save for your children’s college b. Save up cash to purchase your next vehicle c. Invest more money in mutual funds d. Pay off your house That is the traditional order to do things in (a., b., c., and d. are in good order as well). Did I miss anything? Source […]
April 18th, 2008 at 1:01 pm
I had an emergency fund before I paid all debts, I also was contributing to my 401k and my kid college fund automatically
In order words I did all three at the same time
Now I have no debt but a mortage and saving for our next house