Todd and Margo paid all of their bills in November and found themselves with an extra $60 surplus.
What should Todd and Margo do with the $60 budget surplus? On the surface, this question seems like an easy one and to some degree it is. But once you dig a little deeper this otherwise simple question becomes far more complex. In this blog post, I will walk through my decision process to figure out what to do with an extra $60.
This scenario plays itself out more frequently than we might think. Extra money like this can come to us from many sources. From cashback apps like Ibotta and Rauken to the new Apple-branded credit card that gives you daily cashback. Other sources of extra cash might be as gifts or leftover budget money from the prior month.
Like Warren Buffett is to Berkshire Hathaway, you are your family’s asset allocator.
Whatever the source of your newfound cash, your job is to figure out what to do with it. To some people, this question is flat out dumb. I think a fair amount of people would spend this money. But not the debt-free community, we are always paying down debt or figuring out a way to invest it and make that money grow.
Back to Todd and Margo
Todd and Margo have $60 and they have shunned their friends YOLO and FOMO advice and made the diligent choice to save this small but not insignificant sum of money.
Lets set the stage. Todd and Margo have:
- A fully-funded emergency fund has always been a priority for Todd.
- Todd and Margo contribute to their 401(k) enough to get the match from their employer.
- They are on pace to max out two Roth IRA’s this year.
- Tod and Margo have no debt other than their mortgage at a reasonable 4% interest rate, on a Dave Ramsey approved, 15-year mortgage.
Todd and Margo have some pretty good looking finances. They have checked off many of the major steps to get their financial shit together.
- They have an emergency fund.
- They collect their free money from their employer in the form of a 401k match.
- And they are maxing out two Roth IRA’s.
Money triage for your next $60
Based on the decision tree, the priority is to have at least $1000 dollars in an emergency fund for those murphy’s law type events. Car repairs, the furnace goes out, and medical issues. These events would all fall into the category of EMERGENCIES.
Without money in a liquid savings account, like SoFi, people will most likely turn to high-interest loans from credit cards or worse yet, payday lenders. These short term loans will have you moving in the opposite direction of financial freedom.
A quick word about SoFi. It is currently my favorite place to stash savings right now. With a yield of 1.6%, it currently ranks among the highest yielding online savings accounts. I love the “vaults” feature where you can have sub savings accounts for various savings categories. Because we all know we don’t just save for one thing at a time. Additionally, you can order free checks and a free debit card so when it comes time to spend your savings you have immediate access to your money. If you need a better savings-account for your money, SoFi is the place to go. By using this SoFi link you will be supporting The Smart Fi blog and receiving a free $25 after you deposit $100. Go get it!
After the emergency fund of at least $1000 is established. The next place we look to attack with our $60 is high-interest consumer debt. For most people, this would be credit card debt or personal loans. These types of debt have very high-interest rates of up to 40%.
If you have this type of debt, look no further for a place to put your $60 this would be it. Beyond using up your $60, this is the type of debt you pay off like your hair is on fire. You find a side hustle like driving for Uber. You eat food at home and pack a lunch to work. You say no to your friends who want to go to a bar and spend $10 per drink. This is the kind of debt you buckle down and pay off.
Student loans are the next stop for the money triage. With an average interest rate of 8%, student loans are financially harmful over a long period but are not a top priority when compared to credit card debt. If I had a student loan balance this is where my $60 would go.
Lower interest loans
Car loans fit into this category and although everyone hates a car payment, the interest rate on that loan can be anywhere from reasonable to outrageous. The interest rate for an auto loan depends on your credit score and the age of the vehicle. New cars have lower interest rate loans than used cars.
This is one loan where you will have to decide if you should aggressively pay off or let it ride. Dad joke, my apologies. If you have a 0.9% interest rate loan on your new Honda, that is a loan I would not rush to pay off. On the other hand, if you have a 13% loan on a used Toyota, I would pay that thing off with reckless abandon.
After the debt is under control we can now turn our focus to the fun part; wealth building. We next look at putting our money to work to earn us a future income, INVESTING. For Todd and Margo’s fictitious scenario, I have disregarded contributing to their 401k because their money has made it past payroll deduction. Most 401k providers do not allow contributions that are not made through payroll.
Unlike the 401k, Individual Retirement Account (IRA) contributions are made from your take-home pay and are not made through payroll. Although you can set up a direct deposit from your employer to your IRA provider, I advise against this due to the complexity of changing your contribution amount should you desire.
Related: 4 Reasons Why You Need A Roth IRA
In this scenario, Todd is on pace to max out his 2019 contribution at the $6,000 limit. However, after paying off high-interest debt and student loans, a Roth IRA is the next place to put your 60$. Because of the unique tax advantages a Roth IRA provides, I believe every American with a paycheck needs a Roth IRA.
Pay off mortgage
If you have made it this far, congratulations you are most likely debt free other than a home mortgage. At the beginning of this Money Triage exercise, you really didn’t have a choice. If you have no emergency fund and high-interest debt that is where all of your extra money should go.
Now we get to the point where you have a choice. You can pay down your low-interest debt (mortgage) or invest for the future. I wrote an article a while back 4612 Days Until Morgage Freedom. Where I detailed our family’s hybrid plan to pay off our mortgage.
When you get to this point math an emotions collide. The math nerds will clearly show that your money would be better invested in a low cost index fund earning an average return of 8% than it would be paying down a 4% home mortgage.
However, there is so much security in knowing that you have a paid-off mortgage. The bank can never evict you out of your home for late or missed payments.
I toil with this dilemma frequently. Here is why I do both. I split the differnce between mortgage payoff and investing.
For example if I have a $500 surplus after all bills are paid. I send $250 to our mortgage company and with the rest, I buy a low-cost index fund. My favorite is VTSAX (Vanguard Total Stock Market Index Fund).
The last stop on this Money Triage train is my favorite, investing. I love taking my money and sending it out to my various investments to go to work and earn me passive income. I look forward to the day when my money will earn more than I do by going to work.
Say for example I had a $1.5 million dollar portfolio and the stock market returned a slightly above average 10% for the year. My imaginary portfolio would have an annual return of $150,000. That is more than I will ever make in one year. AND it will have been earned without ever lifting a finger. No back-breaking 12-hour shifts, no angry bosses, and no long commutes. All $150,000 was passive income. That is why I invest.
*Disclaimer I am not a financial planner
It took me 20 years of income building to get to this point in the Money Triage plan. For the first 20 years of my working career, I slowly increased my savings every year but it was never enough to max out my 401k and Roth IRA. But every year I got closer and closer to the max until one year we did it. My wife and I maxed out all of our tax-advantaged accounts (401k’s and Roth IRA’s).
It was at that point I knew I needed to start investing in a taxable brokerage account. I logged onto Vanguard and was able to open an account in minutes. There was some paperwork that required a signature and had to go back to Vanguard via snail mail.
To my surprise, my favorite tax-efficient mutual fund, VTSAX, required a $3,000 minimum purchase. After a little research, I figured out I could buy (VTI) the exchange-traded fund (ETF) version of VTSAX with no minimum other than the price of one share, currently $162. After my account balance reached $3,000 I converted my shares of VTI to VTSAX.
When my shares converted to VTSAX, I set up automatic investments every payday that draft from my checking account. *Note: exchange-traded can not be purchased automatically.
3 years later this taxable investment account has grown to a handsome sum automatically. Every payday my Vanguard account quietly siphon’s off some of my money to build an army that is working on my behalf.
I just wrote 1700 words that can be condensed down to one sentence. Pay off your debt and then invest your money. It sounds so simple but it is really not. Which debt is a priority? How do I invest? Do I pay off my mortgage? These are all questions that you will have to find answers to. Hopefully, this article gives you some insight and a place to start. If there was something I missed or failed to explain. Leave me a comment. I would love to give it another shot.