I Got My First Paycheck - Now What?
An important decision every person who starts working their first regular job will have to deal with is what they should do with their paycheck. The obvious answer would be: you’ll use those earnings to pay for your day-to-day costs and save the rest. But if you have any debt (student loans, credit card debt, etc.), which accounts should you focus on paying off first? And what’s the best way to save your money - what will give you the highest return on your savings? One simple method is to simply deposit your paycheck into your savings account. But this is an inefficient way to get the maximum value out of your money.
To get the most bang for your buck, follow the simple flowchart below that provides recommendations on where to put your money. You start in the top left corner (“Emergency Fund”) and if you have money left after that box, move to the next box:
Step 1: Emergency Fund
This is money you put aside for unexpected costs – your car breaks down, a medical emergency, unexpected travel, etc. It’s up to you how much to put into this fund, but you generally want enough to cover 3-6 months of your average expenses. More is always better, of course. An emergency fund can just be a regular savings account. The important thing is that you are able to access and use this money quickly (referred to as “liquidity”) if the situation arises.
Step 2: Company 401k
If you’re employed as a full-time or salaried worker, then there’s a good chance your company offers a “401k”, AKA a retirement account. This can be thought of as a long-term savings account, where you deposit a portion of your paycheck which gets invested (usually) in a mix of stocks and bonds. 401k’s offer great returns and companies usually match however much you put in up to a certain percent. That means, if your company offers a “5% 401k match”, that if you commit 5% of each paycheck to your 401k then your company will deposit another 5% - at no cost to you! If you’re not currently employed, your company doesn’t offer a 401k, or your company’s plan isn’t very good (ex: no matching) – skip this step. Make sure to ask your employer for more information about their 401k offerings and employer matching plans!
Step 3: Pay off debts
If you have any sort of debt that accrues interest or has mandatory payments, this takes the next priority. If you have multiple debts (such as student loans and credit card debt and car payments), then pay off the highest interest debts first. If you have credit card debt, that should often be paid off before anything else, because they usually carry very high-interest rates (see more here). Sometimes, it can make sense to do this step even before the emergency fund or 401k contributions. If any of your debts are very high-interest, you definitely don’t want to be stuck with making payments that increase your debt amount. In general, you want to make any minimum payments your debts require first and then pay down any additional debt on top of those minimums if you have money left over.
Step 4: Contribute to an IRA account
IRAs (the tax shelter for mutual funds) are the next best savings tool - Masada explains what Roth IRAs (a popular form of IRA) are here. As of 2021, you can contribute up to $6,000 per year total to an IRA account if you are under 50 years old. If you can, max out your contributions to this every year. Compounded interest is powerful, and your future self will thank you! However, keep in mind that money taken out of an IRA early will be taxed heavily. So don’t put all your savings in an IRA account, but balance between short-term and long-term savings.
Step 5: “Bad” 401k plans
If your company 401k plan doesn’t offer matching or has other issues, contribute to it only at this point rather than earlier in the flowchart.
Step 6: Other savings and investments
Any leftover income/earnings/money - save the rest in a standard savings account. Or you can use it for other investments, that are riskier or more actively managed by you. For example, some people choose to actively trade by opening an investor account with Robinhood or another company. If you do this, research your investments well or prepare to lose that money. Or, you can spend your leftover cash on whatever you want - it’s your money, after all.
