Once you have completed steps 1 and 2, you should now have some funds freed-up for savings. If you were unable to free-up funds while completing steps 1 and 2, then your expenses are fully optimized, and your journey will stop here at step 3. If you’re still with us, then you have some freed-up funds and may be wondering, “so, what do I do now?” That is a great question! Ask yourself these questions:
a) Do I have a 401K? If so, am I contributing the max amount?
b) Do I have IRA accounts? If so, have I maxed the accounts out this year?
c) So, you have maxed out your 401K and IRA accounts, now what? How’s your emergency fund looking?
d) Your emergency high yield savings account looks good, now what? Do you have a standard brokerage account?
With freed-up funds, I will contribute as much I can to my 401K until reaching the yearly limit. Once I have reached this limit, I will then contribute as much as I can to my IRA accounts. It’s up to you on the percentage of contribution to the Traditional and Roth. I tend to contribute more to the traditional, since I know that I will get more back on my tax return. After I have maxed out the IRA accounts, I will then look at the emergency fund. Do I have enough if something bad happens? If I do, then I’ll start looking at my brokerage account. Honestly, I tend to run out of money well before reaching this point. But, If I have more funds, I transfer them to my brokerage account.
We can get more granular here. Simply transferring funds to your 401K, IRA accounts, or brokerage account does nothing until you choose how you would like to invest the funds. How you choose to invest your savings is determined on your age, risk tolerance, and personal finance goals. I’m a very aggressive investor and like to control and gauge my risk by choosing to invest in target date funds - usually around 2050-2055. You can be even more aggressive. You can choose a few stocks to invest that may yield very high returns. Just remember, usually, the higher anticipated return, the more riskier the investment is.
The cool thing about the target date funds is that they are dynamic. The risk associated with the funds changes over time. The 2055 target date funds may be high-risk now; however, in ten years, the risk associated with the funds will be much less. Investing in these funds takes the headache out of investing by removing the work required to balance an unbalanced portfolio. The target date funds balance themselves over their lifespan.
Index funds have performed very well. A lot of people choose to invest in these funds, based on the historical data. There are also investments called ETFs. Some companies let you trade ETFs for free, as long as you don’t trade them frequently. James Chen’s description of ETFs on Investopedia is great:
“An exchange-traded fund is a basket of securities—such as stocks—that tracks an underlying index. An exchange-traded fund is a marketable security. It has an associated price that allows it to be bought and sold. ETFs can contain all types of investments including stocks, commodities, bonds, or a mixture of investment types.” - article found here.
If you are into purchasing individual company stocks, then Robinhood is a cheap way to go. The company does not charge trading fees; however, you can’t trade too frequently. The app tracks your day trades and limits you to a certain amount. If you are into trading frequently, then TastyTrade may be for you. You can day-trade in a cash account, after your funds have settled, for very low trade fees. The catch is that you cannot trade with margin. For some of us, this may be okay, and for others, this strategy may not work at all.
Overall, if you were able to free-up some funds by completing steps 1 and 2, congratulations! This step, step 3, is the fun step - choosing where to place your funds and how to invest them. If you are like me, and like to invest for the long run, and do not want to do a bunch of research and work in creating a balanced portfolio, then I highly suggest to invest the freed-up savings in target date funds appropriately chosen for the year at which you choose to retire. If you plan on retiring in the year 2055, then choose the 2055 target date funds. If you plan to retire in 2040, then choose the 2040 target date funds, etc. Further investment breakdowns will be discussed in the next step (step 4).
The goal is to put every dollar you have to work. You may find that your relationship with money may change after you make each dollar in your savings work for you. This was the case for me. I had always felt that money was working against me. When you make it work for you, you realize that you are in this together and can help each other along the path towards financial independence.