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Prioritizing Your Investments

Reaching your financial goals isn’t just about saving as much money away as possible, maxing out your 401(K), or getting rid of debt. It’s a systematic and mathematical approach that compares the interest rates of your various debts and the characteristics of the investment accounts available to you. When done correctly, you can pay off debt and build wealth much faster than randomly investing and paying off debts.

Step #1: Make a Rainy-Day Fund

Imagine you’re enjoying a routine Saturday when suddenly, your car breaks down. While this isn’t a catastrophic event, fixing a car can cost anywhere from several hundred to a couple of thousand dollars, if not more, an expense many people might not be able to cover comfortably with their monthly income.
That’s where a rainy-day fund comes into play. By having a fund that covers three to six months of living expenses, you can handle unexpected costs without going into debt or stressing out. This fund should be kept in a readily accessible, low-risk account like a savings account or money market fund; if you keep these funds in illiquid assets like bonds or stocks, you may not be able to access them in a timely manner.
Liquidity is key. Now, I’m not saying you should keep thousands of dollars in your mattress, either. Inflation is eating away at your money when it’s not invested, so at least a money market account or savings account will provide at least a bit of an interest rate to help lessen the blow of inflation.

Step #2: Pay Off High-Interest Debt

It’s basically impossible to find a guaranteed return on your investment. But that’s precisely what you’re getting when it comes to debt. However, rather than earning money, you’re saving it. Let’s use credit card debt as an example; you’ve racked up 50k on your card at 15% interest. You stop using it and start paying it off. Three long years later, you’ve paid it off while giving the credit card company over $12,000 in interest. How kind of you!
Now factor in all the other forms of debt you have and how difficult it is for your investments to keep up with that kind of interest rate. In fact, they probably can’t. It’s nearly useless to start putting money into your investment accounts until you’ve first paid off that high-interest debt.
So triple down on those credit cards – they’re probably your most significant hurdle in achieving long-term financial success.

Step #3: Maximize your Employer's 401(K) Match

A 100% return on your money is very rare. A guaranteed 100% return on your money is even rarer! But that’s what happens when you contribute up to the company match into your 401(K). Free money is hard to come by, and your employer is offering essentially that. The savings potential is massive. How massive? Using Bankerate’s 401(K) calculator, we can see just how much more you can end up with.
401(K) company match graph
Putting 10% of a $100,000 salary that grows at 2% a year, with a 7% annual rate of return for 35 years, will net you an additional $540,000 when you retire, assuming a 100% match on 3% of your salary.
Take advantage of that match!

Step #4: Max Out Health Savings Account (HSA)

A Health Savings Account, or HSA, is one of the most tax-efficient investment vehicles available. Here’s why:

Tax-deductible Contributions

Any amount you contribute to an HSA is tax-deductible. For example, earning $60,000 annually and contributing $3,000 to your HSA, you would only pay income tax on $57,000.

Tax-free Growth

Once your contributions are in the HSA, they can be invested, similar to how you might invest in a retirement account. The significant advantage here is that any returns on these investments, such as dividends or capital gains, aren’t taxed, allowing the money in your HSA to grow faster over time since it’s not being reduced by taxes.

Tax-free Withdrawals

When it’s time to use the funds in your HSA, any withdrawals you make for qualified medical expenses are completely tax-free. Qualified medical expenses can include things like doctor’s visits, prescription medications, mental health services, and more. This means you effectively pay for these medical costs with pre-tax dollars, giving you more spending power.
To qualify for an HSA, you need to be enrolled in a high-deductible health plan (HDHP). As the name suggests, HDHPs have higher deductibles than typical health insurance plans, but lower premiums, making them a good choice for individuals who are generally healthy and don’t anticipate needing extensive medical services. Combining an HDHP with an HSA can lead to significant healthcare savings now and in the future. It’s worth noting that not all high-deductible plans are HSA-eligible, so be sure to verify this with your insurance provider.

Step #5: Employee Stock Purchase Plan (ESPP)

Many companies allow employees to purchase company stock at a discounted price, providing either a nice bonus or a stake in the company’s future if you decide to hold. However, this isn’t a guaranteed investment like paying off your high-interest debt or a company 401(K) match. There is considerable risk that if you buy the stock at even a discounted price, the price could drop by the time you’re ready to sell it, even if that time frame is a matter of minutes.
If you decide to simply buy and hold, your portfolio may be top-heavy with your company’s stock, going against the principles of diversification. And again, your company stock may drop below the price you bought it for, leaving you with only the hope of a price increase or a series of dividends to get you out of the red.
In most cases, it only makes sense to purchase company shares and immediately sell them. Then, use those funds to invest in various ETFs and mutual funds.

Step #6: Maximize Contributions to Your 401(K)

You’re already putting in as much as needed to get the full company match. Now, it’s time to max out your 401(K). There are a few reasons for this – firstly, your 401(K) is tax-advantaged. Either you won’t owe taxes on contributions and growth until retirement, or, if it’s a Roth, you pay taxes on your contributions, and your funds will grow tax-free, assuming you follow the withdrawal guidelines.

Step #7: Max Out an IRA or Roth IRA

We put this after maxing out your 401(K) for one reason: the maximum contribution limit is much lower for an IRA than for a 401(K). However, there are some nuances we should consider. If your workplace 401(K) is laden with high fees or comes with severely limited investment options, you may want to max out your Roth IRA first.
2023 Contribution Limits
Unlike a 401(K), an IRA is self-directed, meaning you have complete control over your investments. Essentially, the whole stock market with its associated Mutual Funds, ETFs, and REITs, among a slew of other options.
The next question is whether to contribute to a Roth or a Traditional IRA. A tax-focused investment advisor can help you make that determination, as you must look at your lifelong tax situation and overall financial picture.

Step #8: Pay off your low-interest debt

Traditional wisdom says to pay off your debt as fast as possible. However, the S&P 500 has an average rate of return higher than low-interest debt. For example, it certainly outpaces a 3% mortgage, especially if you reinvest the dividends you earn. So, you’re likely to build wealth faster by focusing on investments before paying off your mortgage. Inflation will also be on your side too if you can hold off on paying that loan back.
The choice is, of course, yours, though. If you’d like to get out of debt as fast as possible as a matter of principle, then go for it!

Step #9: Invest in a Brokerage Account

So far, we’ve focused on tax-advantaged retirement accounts as the main path to building wealth. However, a regular brokerage account also has plenty of tax advantages you can utilize.
Tax Efficiency
ETFs and mutual funds that track broad market indexes tend to have low turnover. This means they buy and sell securities less frequently than actively managed funds, leading to fewer capital gains distributions that you’d have to pay taxes on, making them more tax-efficient.
Flexibility for Tax-Loss Harvesting
With a taxable account, you can take advantage of tax-loss harvesting. This strategy involves selling a security that has experienced a loss and using that loss to offset gains from other investments, helping you reduce your taxable income and potentially lower your tax bill.

Finally: Avoid Investing Mistakes!

The Fear of Missing Out is real. Don’t pull from your retirement account to invest in the next big crypto coin, NFT, or any other trending ‘investment’ product. Another huge mistake is selling your investments because of a big crash. Here, you’re doing the opposite of wise investing by buying high and selling low. A careful investing strategy utilizing portfolio rebalancing and dollar-cost averaging can reduce these risks and build your wealth much faster.

In Conclusion

To summarize, an effective investment strategy means not touching your investments. Let them grow! You can do that by creating an emergency fund. Next, you need to implement a balanced approach of paying off debts and making investments by assessing actual and projected interest rates while considering the tax implications of the investment accounts accessible to you. Easy, right?
By avoiding financial pitfalls and adhering to these principles, you are setting up a mathematical framework that will accelerate your wealth.
Need help prioritizing your investments? As dual CPAs and financial advisors, we’re well qualified to put the plan that makes the most sense for your unique situation. Just click the button below to begin your journey.

About the Authors

  • Douglas Walters

    Doug is the Managing Partner of Walters Strategic Partners, LLC, a licensed Registered Investment Advisory firm. Doug is a licensed Certified Public Accountant (CPA) in the state of Florida and holds a Series 65 Investment Advisor Representative securities license. He is also a member of the AICPA. With over 28 years of experience as a CPA, he believes investment decisions should be based on decades of peer-reviewed research rather than relying on the latest “hot tip” from media outlets. This empirical evidence puts the science of investing to work for his clients.

  • Jose Joia

    Jose M. Joia is a Wealth Advisor at Walters Strategic Advisors, LLC. As a member of the team, Jose’s responsibilities involve comprehensive wealth management, planning and customer service. He has over 6 years of industry experience specializing in planning and solving unique issues his clients encounter. Jose has experience serving individual clients, business owners and non-profit organizations.

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