At the end of step 3, I began to discuss how you can put your money to work for you. For the longest time, I kept my savings in a brick and mortar bank savings account which earned next to nothing interest. This was a huge mistake. I should have been investing each dollar strategically in order to earn worthwhile returns required in the compound interest over time process. As soon as I realized how to do this, my financial mindset began to change for the best.
Everyone preaches diversification, and I agree with them; however, they don’t preach how to diversify. Do you buy different funds within one brokerage account? Should you buy the same thing in different accounts? Should you even have multiple accounts? These are great questions that seem to be hard to acquire answers.
One way to attack your savings goals is to set up a structure. In the world of data and databases, you can take a full backup every night (one savings account), or you can implement a backup chain that consist of a full, differential, and transaction-log backs, daily (multiple savings accounts - savings chain). This chain allows you to diversify your savings by placing it in multiple accounts. Not only will this help control your risk, it will create an extra level of security from internet hackers. So, what accounts should you have and how should you invest the money once it’s in those accounts?
If you have access to an employer sponsored 401k account, you should contribute as much as you can - especially if the employer offers a match. The match is free money and should be taken. Think of your 401k as your full backup; this account is the first one in your savings chain. What’s next? Well, you need your differential backup. This is your Roth and Traditional IRA accounts. Once you contribute as much as you can to your 401k account, if there is any left over, you can contribute the amount to your IRA accounts. How you distribute the funds between your accounts is up to you.
Now, you may be thinking, what if I can max both 401k and IRA accounts for the year? What do I do then? First, you can pat yourself on the back. This is very hard to do and if you are in a position to do so, be extremely grateful. Very few people can do this. If you are able to, you can open up a brokerage account and invest the money how you choose. Keep in mind here, if you are familiar with database backups, you may have noticed that I left a backup out. Yes, I did; I left the full monthly backup out - here’s where it comes into the savings chain. The full monthly backup is your emergency savings account. I recommend that this be a high yield savings account. This account will earn you high interest with low risk. No-penalty CDs should also be considered.
Your emergency fund should be number one priority. Set some funds aside, and once you have done this, then begin contributing to the first account in the savings chain - the 401k. Now that we have established the structure - the savings chain - how should you invest your money once it’s in the accounts? I invest high risk to low risk in the savings chain. What I mean is that I choose to be very aggressive with the funds in my 401k. Then, I’m a little less aggressive with the funds in my IRAs. With my brokerage, I’m a little conservative. The risk of my investments decreases as I move through the accounts in my savings chain.
Investing is much more than making binary choices. If you do this, then you will become wealthy over time - this is not necessarily the truth. To think of investing properly, you need to view it as a spectrum of choices. A choice along the spectrum may not be right. It may not be wrong either, and the outcome may be financially beneficial. There are no right nor wrong ways to invest. There are however very risky investments that you should stay away from. It is up to you to do your research and determine which investments fit within your risk tolerances. Please learn from my mistakes; it is my goal to get us to financial independence as quickly as I can.