Updated: May 7
Before you start investing, you should do some house cleaning first.
Below are three things to keep in mind.
1. Building an Emergency Fund.
The emergency fund’s whole purpose is to build a safety net for unforeseen events in your life. If you get laid off or get into a car accident and can’t work, the emergency fund is immediately available for you to use until you can get back on your feet again.
The emergency fund should be enough to cover at least 6 months or 1 year of expenses. Once the emergency fund is used, you need to replenish it back to its original amount. So if you had saved $20,000 to cover 6 months, and you had to withdraw $10,000 for emergency use, you should make that $10,000 back overtime to bring the account back to $20,000.
If you don’t have an emergency fund in place yet, I encourage you to start with $1,000 dollars first. Do whatever it takes to save up that $1,000 fast within one month.
2. Pay off High-interest rate debts.
Paying off debt is one of the hardest things for an average American because we are accustomed to installment payments and we continue to accumulate debt through credit cards, student loans, car loans, and/or mortgages.
You should start with the debt that has the highest interest rate first and focus on paying it off.
Credit cards are the worst debt as it has the highest interest rate of all. I, myself, do not have credit card debt since I pay my credit bill in full every month. In the past, my parents had so much credit card debt and they used the method of transferring the debt to different credit cards after 18 months or so to avoid the interest fee. This was a nightmare as they kept racking up more expenses on the credit card.
If you have credit card debt then you need to pay them off fast. Save every dollar and just pay it down. Set a short timeline for yourself to pay them off. This will motivate you to focus on debt elimination. Afterward, you can move on to paying off student and car loans.
Mortgage is a tricky subject especially at this time when the interest rate is so low.
This is my take: if you have a high-interest rate on your mortgage, then you can consider refinancing to a lower rate. In my case, I bought my house in 2014 and the rate was at 3.85%. As the interest rate went down to 3%, I still didn’t think it was worth it to refinance. Comes fall 2020 when the rate was around 2.5-3%, I refinanced for 2.85%.
A lot of people refinanced and made the mistake of not taking advantage of the extra money they have leftover since their new monthly payment is lower than before. They used that difference in “savings” to spend frivolously.
Keep in mind the terms of refinancing. If you refinance with a 30-year term to lower your payment, you are stretching your mortgage out longer, that is if you are just paying the bare minimum. In my case, I refinanced to a 30-year so that I no longer am obligated to the high payment of a 15-year term. However, all the extra “savings” are still applied to the principal bi-weekly, so this way I am still on track to paying off my mortgage early as planned.
To pay off your mortgage early, some lenders do let you do weekly payments or bi-weekly payments. This helps you pay off your mortgage faster and save you on interest since the interest is calculated on a daily basis.
So back to the question “should I pay off my mortgage before investing?”
Because the interest is so low now, it’s not worth it. The average market return is 8% annually. I decided it’s not worth it to try to pay off my house quickly and missed out on that 5% return. Your perspective might differ and you may want to pay off everything before investing since no two households are the same.
3. Budget, plan, and save for big purchases.
It’s pretty self-explanatory, right? If you want to buy something then you should save up. But, generally, people don’t save enough and they either put a large percentage of the cost on a credit card or a loan. Debt then continues to rack up over time. So do yourself a favor and save up for the big item expenses like a new car or a family vacation.
I set up multiple savings accounts for big purchases I plan to make in the future and have it automatically pull the money out from my main account at certain intervals of the month.
I have my main spending account where my paycheck is directly deposited into.
An account for an emergency fund.
An account to buy a new car in the near future.
An account for general allowances.
Each month, money is distributed from the main account to the other accounts until it reaches my desired goals.
By having multiple accounts the money is kept out of sight. It helps me from overspending. By planning all these future purchases ahead of time and saving incrementally, it gives me a sense of security and I am in a better position to handle emergencies that may come my way.
One of the habits I have built after getting married is doing our family yearly expenses and then budget our expenses for next year. I believe this is one of the important steps to make your money work for you, is by tracking where they are being spent. In my single years, I did not track my money so when I looked at my account I had no clue where they went. I end up being overwhelmed and felt that I never made enough because my saving account doesn't grow.
Therefore, I recommend that you do your expense at least once a year. It is even better if you could do it monthly or every 6 months.
Some of us may think these are obvious points, but many of us may not know how to implement them into our busy lives.
I did not know about the need for an emergency fund until after I got married, and only after my wife signed us up for financial class.
Having an emergency fund gives me the peace of mind that I don’t have to tap into my other savings.
When we first accomplished our emergency fund, I felt relieved and secured. If something were to happen to me, I know that my family would have a solid financial standing to fall back on. I also don’t feel like I have to keep working to save while making no progress.
I had to use our emergency fund recently in the middle of April 2021 to purchase a car because the old one suddenly became unusable. I never thought I would need to use it this soon, but life happens.
When it comes to eliminating the debt process, I didn’t know how effective it was to prioritize and focus on one debt at a time. I was so used to the way of paying the bare minimum of all the debt.
In the past, my siblings and I helped our parents pay off their mortgage in just a few years by chipping in each month. We reviewed their spending and focused on every dollar they saved in order to pay off that mortgage. This was one of our biggest financial achievements.
I believe that the process of focusing on eliminating one debt at a time in a short period of time will give you a sense of accomplishment and keep you motivated in achieving your financial independence.
By taking my end goal and breaking it into bite-size goals, I gained a sense of relief, security, and accomplishment. Seeing that I have made some progress keeps me motivated onward towards my FIRE plan.
Time is Money! So the earlier you start your Financial Independence journey the faster you will get there.
*Disclaimer. I am not a financial advisor. The contents on this site are referenced as opinions and are for information purposes only. It is not intended to be investment advice. Please seek a licensed professional for investment advice.