Is There an Order of Operations When It Comes to Investing?
Investing is vital for long-term financial success. But what should we prioritize? Is there an investment order that we should follow?
October 1, 2021
Getting started with investing can feel incredibly intimidating. We all know that we should be investing, but there are so many options that it can feel overwhelming. Should you focus on retirement savings or save for a short-term goal? Should you try to pick stocks or stick with lower-risk bonds?
While there is no definitive investment order that makes sense for everyone, this guide will help point you in the right direction. We will lay out a basic order of investments for retirement and other goals, so that you can prioritize your efforts and make progress toward a brighter financial future.
Tier one: cover the basics
Before you start investing, it’s important to have the basics of your financial life in order. This means:
Being able to cover all bills without adding debt
Having a reasonable emergency fund
If you meet all these criteria, you’re likely ready to start investing.
Tier two: maximize employer matching benefits
If your employer offers a retirement plan with employer matching, your first priority should be to maximize this benefit.
This benefit essentially means that if you contribute to your employer-sponsored retirement plan, your employer will match your contributions up to a certain limit.
For example, an employer may match 100% of your contributions equal to up to 3% of your annual salary. If you make $50,000 per year, this means that if you contribute $1,500, your employer will also contribute $1,500 to your retirement plan.
The specifics of this benefit vary by employer, and some companies do not offer matching at all. Check with your HR department for details.
Tier three: pay off high-interest debt
Paying off high-interest debt should be another top priority. This includes credit cards, payday loans, personal loans and any other debt with an interest rate exceeding 10%.
This tier does not include lower-interest debt, such as mortgages or car loans.
Paying off debt might not seem like an investment, but look at it this way: If you pay off debt that has an APR of 20%, you are essentially earning a 20% return on the money you used to pay off that debt.
Tier four: retirement savings
You have likely heard about the importance of investing for retirement as early as possible, and the advice could not be more true. Through the power of compound interest, relatively small investments early in a career can grow into a large nest egg.
Investing just $100 per month throughout the course of a 45-year career would grow into more than $350,000 by retirement age, assuming average returns of around 7%.
There are several ways to save for retirement, but in general, it’s a good idea to use tax-advantaged retirement accounts such as:
If you are self-employed, your account options include the SEP IRA and the Solo 401k.
These accounts offer powerful tax benefits that can help maximize your retirement savings. The best account to use depends on a few factors, including whether your employer offers a 401(k) and what your current income level is. Speak with a tax professional or investment advisor for help.
Tier five: saving for future required expenses
If you have any upcoming required major expenses or purchases, this could be the next focus of your investment planning. These expenses might include:
Future college expenses, for yourself or a child
Future professional certifications, training, conferences, etc.
Future vehicle repairs or replacement
Future major house repairs
This category could include any major expenses that will come at least 5 to 10 years down the road. If you have major expenses coming sooner than this timeline, you might want to avoid investing those funds and instead think about keeping them in a savings account.
Tier six: saving for future optional expenses
Saving for optional expenses and purchases would come next in this investment order. These expenses could include:
Future travel and vacations
Future optional purchases, like your dream vehicle
Future major gifts or donations
Because these are optional, they would be your lowest priority in most cases.
When to invest in stocks and when to invest in bonds
Getting your financial goals and priorities straight is important. It’s also vital to understand how you should invest for each of your goals.
There are a wide variety of asset classes available to invest in, including:
Stocks, also known as equities
Mutual funds and ETFs
Bonds and bond funds
Certificates of deposit (CDs) and treasury notes
If you are new to investing, it’s helpful to think of the various asset classes in terms of their risk levels.
Riskier asset classes include stocks, mutual funds, ETFs and cryptocurrencies. Bonds, bond funds, treasury notes and certificates of deposit (CDs) are considered low-risk investments.
Generally speaking, riskier assets produce better returns over the long run, but with much more volatility along the way.
In other words, over a 30 year period, stocks are almost certain to be more profitable than bonds. But over a three year period, stocks could easily lose money, while bonds produce a small profit.
By this same logic, investing in stocks makes the most sense for long-term investments, including retirement savings. Lower-risk investments like bonds and CDs make more sense for short-term savings, or for any funds that you will need to access within the next 5 to 10 years.
To decide on an investment strategy, you will need to consider your goals and your risk tolerance. If you are okay with risk, focusing on growth investments, such as stocks, might be a good idea. If you are more risk-averse, you could try a more conservative portfolio containing mostly bonds and a small amount of stocks.
Are you stuck in tier three and need help paying off credit card debt? Check out Tally†, a debt payoff app that helps you manage, track and pay off debt faster.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.