Fund your 401(k) first, says the author of 'I Will Teach You To Be Rich'—here's whyApril 22, 2019
Financial experts frequently recommend that you invest in your retirement accounts and that you also make sure you have an emergency savings fund. What should you prioritize, though, and how?
Personal finance expert Ramit Sethi tells CNBC Make It that, while your priorities will depend on your situation, he generally recommends you start with your retirement savings, especially if your employer offers a 401(k) plan.
Why your 401(k) is a good place to start
About 47% of those aged 25 to 34 have access to a workplace retirement plan like a 401(k), according to a recent academic report from Stanford University. It’s important to start investing ASAP — in your 20s, if you can — since the earlier you get going, the easier it is to end up a millionaire.
A 401(k) plan is great because it offers significant tax savings and it’s convenient. You can put in money from your paycheck before taxes are withdrawn, which reduces your taxable income. That means you will pay less in taxes each year. And your contributions are automatically deducted from your pay, so you won’t be tempted to spend the money now instead of putting it towards your future.
The best way to maximize your 401(k) savings
Sethi, the best-selling author of “I Will Teach You to be Rich,” says not enough people take advantage of an important 401(k) perk: employer matching programs.
These are generally included in your work benefits. Your company may offer to contribute the same amount that you do, up to a certain point. For example, if you put 5% of your salary into your 401(k), your employer may also contribute 5%, depending on the type of program. The median matching level is 4% among Vanguard 401(k) plans.
“That’s your company literally saying: ‘Hey, here’s some free money, do you want to take it?'” Sethi, the best-selling author of “I Will Teach You to be Rich,” says. “If you don’t take that, you’re making a huge mistake.”
Find out from your supervisor or HR manager if your company offers a 401(k) match. “It’s OK to ask if you don’t know,” Sethi says. If the answer is yes, then do your best to max out that match. “That turns out to be worth a huge amount of money,” he says.
If it turns out your employer doesn’t offer a 401(k) or a match program, it’s still worth putting some money away in a retirement account. Vanguard recommends working your way up to saving a total of 12% to 15% of your income for the long term, including the match.
And once you have your 401(k) account set up, it’s important that you select how to invest your funds — otherwise your retirement money will essentially act like a savings account. Consider investing your dollars in a target-date fund, suggests Sethi, since that kind of a fund is a popular, low-cost and effective solution that does the balancing for you and largely takes the work out of your hands.
So fund your 401(k)—but don't neglect emergency savings
If you max out your 401(k) match, great. Then you have a decision to make with any leftover money, Sethi says. Should you put more in your retirement fund or should you build up your emergency savings?
If you can, do both, Sethi says. But he recommends continuing to prioritize retirement. “It’s great to start investing as early as possible because over time, that money will turn into a lot,” he explains.
There’s a lot of room to invest with a 401(k). In 2019, you can contribute up to $19,000, and if you’re over 50 you have some additional opportunities to put in even more.
Say you have $100 left over at the end of the month after maxing out your 401(k) match. Sethi suggests putting $75 of those dollars in your 401(k), which might mean adjusting your contribution level.
With the remaining $25, Sethi recommends setting up an automatic transfer from your checking account into a savings account every month. To make your money work for you, consider a high-yield online savings account like Ally’s, which is currently paying 2.2% APY.
Having an emergency savings fund can be an important way to take control of your finances and avoid racking up debt for unexpected shortfalls such as car or home repairs. “That’s going to be a buffer between you and high-cost credit card debt,” says Ted Rossman, credit industry expert for CreditCards.com.
Experts say your emergency savings should start around $500, although that can take time to build up even that amount. So start off small, says David Bach, co-founder of AE Wealth Management. Consistently save a small percentage of your paycheck by setting up automatic transfers, he says.
Over time, you should aim to have three-to-six months of living expenses set aside in an account earmarked for emergencies, according to experts.
Sethi agrees: Don’t neglect the present while you plan for the future. “I do want you to build the habit of automatically investing every month and automatically saving every month.”
Don’t miss: How much money you should save in your 401(k), according to the author of ‘I Will Teach You To Be Rich’
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