Prioritizing Finances and Investments

"A wise man should have money in his head, but not in his heart."
Jonathan Swift (1667 - 1745)

One of the key points to success in your personal finance is learning to prioritize what exactly to do with your money. This is one of the harder things to do because it requires patience and self discipline to stick to a plan that you have created. In this article, I will be sharing with you my list of priorities in relation to my personal finances and goals as well as explain why I chose this particular ranking.

Below is the ranking of importance in my personal finances:

1. Checking AccountSavings Account (directly linked to checking account to prevent overdraft)
2. Emergency Fund (In high-yield savings account [e.g. HSBCDirect, INGDirect])
3. 401(k) (through my employer)
4. Roth IRA (Reputable Mutual Fund company [e.g. Vanguard, TRowePrice])
5. Mutual/Index Funds (Reputable Mutual Fund company [e.g. Vanguard, TRowePrice])
6. Individual Stocks (Through an online broker, refer to post "I have money, now who do I invest it through" for more information)
   

Checking Account

The checking account is the first priority because typically this is what most people use to pay their expenses and bills such as utilities, rent/mortgage, car payment, etc. It is important to have this account funded properly at all times so that bills are paid on time and bills can be paid in full without having to overdraft this account. This is also typically the account that most people choose to have their paychecks deposited to. I personally allocate funds from this account to fund my other accounts.

Savings Account

The whole purpose of my savings account is to prevent any type of overcharge fees from my checking account. This account is insurance for my checking account so I do not incur any unnecessary fees, further depleting my usable income. I typically keep this account a little above the minimum balance as specified by my bank so I do not incur any fees for it.

As mentioned earlier, since this account is only used as "insurance" it should not be constantly withdrawn from to cover back-to-back overdrafts. Since most savings accounts are covered by Federal Regulation D, you are limited to 6 overdraft transfers a month. For more information and details about this regulation, please click on the following links:

Regulation D FAQ
Regulation D
Regulation D Offerings
Regulation D -- Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933

Emergency Fund

The Emergency fund is the most important account I own. It contains approximately 5 months of my take-home salary that will hold me over in the event that I lose my job, become disable or encounter a major unplanned expense. The Emergency Fund is an account that I do not have easy access to. Since I have it all online with HSBCDirect, it takes approximately 3 days for me to receive money from this account once I have requested it. This is perfect for this type of account because that typically discourages me from using this account for anything else besides an emergency.

The reason I suggest keeping an account like this directly with an online bank is due to the fact that there is a stable interest rate that usually pays more than standard bank account. In addition to that, you do not have to worry about your money invested dipping below your original amount deposited. This refutes the idea of using a personal Individual Retirement Account (IRA) as your emergency fund due to the fact that IRAs are volatile and run the risk of being "down" at the time that you need to withdraw from it.

401(k)

The employee sponsored 401(k) is typically the "nest egg" that most people use to retire. Since this money is taken out pre-tax, it adjusts your taxable income and has potentially tax benefits that can make the difference in the amount of taxes you owe the government at the end of the year. In addition to that, most employers contribute some form of matching up to 6% of the employee's contribution (which translates into FREE MONEY). There is a 15,500 limit by law (reference) that you can contribute annually to this fund. However, I have set my own personal limit to 15% of my annual salary. This was done so that I can continue to invest my money through other investment vehicles.

Roth IRA

The Roth IRA is probably the best investment vehicle possible besides the 401(k). Typically, the 401(k)'s benefits exceeds the Roth IRA only due to the fact that most employers offer some type of "matching" plan for employee contributions and because the 401(k) can lower the overall taxable income. However, if the employer does not contribute to the employee's 401(k) at all through matching, then the benefits of the Roth IRA mostly outweigh that of the 401(k). The biggest benefit of the Roth IRA is that it is not taxed at all when it is withdrawn (pending that you meet your eligibility to withdraw requirements) For more information on some of the benefits of the Roth IRA, refer to the following links below:

Roth IRA by Wikipedia
401(k)/IRA Matrix

Mutual/Index Funds

For beginning investors, mutual and index funds are the best introduction into the stock market. The reason why these are the best way to enter into the market is because it offers the two key requirements in successful portfolios: Diversification and Low-maintenance. Typically index funds are better than mutual funds because they usually have a lower Expense Ratio ,with a comparable amount of diversification. Also, these are great for the buy and hold strategy where one can contribute a set amount of money each money to a steady investment to allow it to grow over time.

Individual Stocks

The last financial priority should be investing in individual stocks, however this is commonly one of the higher priorities on most people's list. I, too, am guilty of mis-prioritizing this particular vehicle and was severely burned by this strategy. Individual stock picking requires a lot of research and time that most people are not able to invest. It is very rare that novice stock investors will be able to beat the S&P Index fund's average return rate approximately 15% in their first year of trading. My recommendation is to fund the higher priority vehicles first and then use any left over money (that you do not mind losing) to play individual stocks.

Overall, my priorities may not fit your financial situation. Different people have different needs and goals that they have set as to what they want to accomplish. This particular methodology works well for me and has so far allowed me to stay on top of my finances as well as plan for my future. Please let me know your thoughts below and any other strategies that you have in the comments section. Remember...stay disciplined!