As Dave sat down to work on his bills Monday morning, he found out how badly he was mismanaging his money.
Dave wasn’t mismanaging his money like everyone else. Dave was different. He wasn’t throwing away money on the lottery or going on wild shopping sprees for fancy cars and electronics he couldn’t afford.
Dave is different because he’s 30 years old, with no kids or debts, and an extra $4,000 a month. It’s hard to feel sorry for Dave, I know, but let’s look at what he could be doing better.
Right now, Dave’s missing an opportunity to become very wealthy and have a retirement he can enjoy. If he doesn’t use his money well, he’ll be stuck working past the ripe young age of 59.5, just like the rest of us.
So what should you do if you have too much money each month?
Build an Emergency Fund
If Dave’s smart, he’ll start stashing a few months’ pay for an emergency fund. At minimum, he should have three to six months of living expenses saved.
To do that effectively, he’ll need to tally his monthly bills and living expenses, then factor in eating out and entertainment. He can add an extra thousand dollars as a cushion, then multiply that number times six to reach his emergency fund’s grand total.
Once he’s done that, Dave should move on to longer-term savings.
Max Out Your 401K
Once he’s built his emergency savings, Dave should consider maxing out his 401K contributions for the year. For 2013, it’s $17,500. So, to find out how to max his contribution, he’ll need to divide his salary by $17,500 to find out what percentage he needs to tuck into his 401K. After that, he’ll need to work with his HR department to adjust the totals on his paperwork.
What if your employer doesn’t offer a 401K, or you’re self-employed? You can still contribute to your own 401K. It’s called the Solo 401K. Your contributions will be maxed out at $51,000 a year ($56,500 for age 50 and older).
Start a Roth IRA
After maxing out his 401K contribution, Dave will want to extend his other savings into a Roth IRA. The maximum yearly contribution is $5,500. If he exceeds the yearly income for that, he can move into a backdoor Roth contribution via his Roth custodian.
Invest in Index Funds
Next for Dave’s active savings are index funds. Index funds are set up on an index market like the S&P 500, and they perform at market value. This means that they never outperform or underperform the market.
These are great investments, because they don’t require the same hefty fees as actively-tracked investments. They’re long-term performers, so they’re usually established and left alone, unless something drastic happens in the market.
Of course, there’s no reason that Dave couldn’t start splitting his $4,000 extra and contribute everywhere at once. But this is a less confusing, step-by-step process — and with $4,000 extra to stash, it won’t take Dave long to reach his emergency fund goal.
And lastly, you’ll probably note that this is an aggressive plan of attack to fund his retirement at the normal retirement age. He could very well up the ante and retire early, or fund some businesses that could net him an excellent return.
Where else would you invest if you had too much money each month?