If your living expenses are taken care of and you're deciding where to put your next dollar, following a financial planner-created framework might be helpful.
Here are the stepsPhuong Luong, certified financial planner and founder of Just Wealth , considers when working with clients. She said these steps are largely applicable to people at any life stage, except retirees who may have already hit their biggest financial milestones.
1. Check your foundation
There are a few things that need to be addressed before you should begin investing, Luong told Business Insider.
"Building a strong financial foundation includes having a healthy emergency fund and paying off all high-interest rate debt, like most credit cards," she said.
Credit-card debt is all too easy to rack up, especially in times of financial crisis. The average credit-card interest rate in the first quarter of 2020 was around 15%, according to data from the Federal Reserve. That's more than twice the potential average earnings of a stock market investment. In other words, even if you earned the average return investing, it will be canceled out, and then some, if you're sitting on credit-card debt that's accruing interest.
If you don't yet have an emergency fund, move on to step 2. If you do, move on to step 3.
2. Build an emergency fund
A "healthy" emergency fund consists of at least three months worth of expenses saved in cash, Luong said. (Although during the pandemic, many experts recommend significantly more .)
"If you're not sure how much you need to save and keep as cash in an emergency fund, then track your expenses for a few months to see how much your life really costs," she said, adding that you might want to keep even more cash on hand if you financially support other people or work for yourself.
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3. Invest in an employer-sponsored retirement plan
After you've paid off high-interest debt and established a savings cushion, begin investing in your retirement plan.
If you have access to an employer-sponsored retirement plan, like a 401(k), that offers an employer match , start by contributing at least enough to meet the threshold, "so you can take advantage of that valuable employee benefit," Luong said.
And remember that a retirement plan isn't just a savings account . You might be saving for your future expenses, but you should put the money to work by choosing investments within your plan that match your risk tolerance and time horizon.
4. Evaluate your short-term goals
"If you still have additional cash available at the end of each month, think about what your goals are," Luong said.
Separate your goals into two broad categories: short term for events or purchases happening within five years, and long term for events or purchases taking place five or more years from now. These goals can be anything from amassing a down payment for a home to paying for a wedding or starting a small business, she said.
Luong said she usually advises against investing money you need for short-term goals.
"It's best to save it as cash in a high-yield savings account so you can at least get some interest from it beyond what you'd get from your checking or regular savings account," she said.
5. Consider maxing out retirement accounts
If you don't have any major purchases on the horizon, you can shift your extra money into long-term investments, Luong said.
Contribute as much as you can to your employer-sponsored retirement accounts and IRAs in an effort to "max out" these tax-advantaged accounts. For 401(k)s in 2020 the maximum contribution total is $19,500, with an additional $6,500 catch-up contribution if you're over age 50. Traditional and Roth IRAs have an aggregate contribution limit of $6,000 in 2020, plus an extra $1,000 if you're over age 50.
"The tax benefits of these types of accounts can lead to major savings over time," Luong said.
6. Utilize a Health Savings Account
"Once you've maxed out those retirement accounts, consider saving in a Health Savings Account (HSA) if you have a high-deductible health insurance plan," she said.
HSAs help you save for health expenses while paying less in taxes. They operate like a savings account, but once you reach a certain balance you can invest the remainder to earn more on your money. Contributions, earnings, and qualified withdrawals are tax-free. Plus, the funds in an HSA never expire you can use them now or later in retirement.
7. Invest for long-term goals
"If you still have extra cash after considering the steps above then start exploring ways to invest it in service of your long-term goals," Luong said.
Before you invest in a brokerage account that is, a taxable investment account it's important to consider whatyou're investing for.
The type of investment, and whether you go with stocks, bonds, or even real estate, depends largely on how much risk you can stomach stocks are generally riskier but may offer a higher return and when you need to sell your investments to fund a purchase.
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