Build your wealth smarter with this bulletproof 7-step plan to conquer every level of the financial game. We’ll talk retirement accounts, asset allocation and even touch on real estate.
I hear some variation of the below questions constantly:
- How do I start saving / investing?
- I have $5,000 saved up…what should I do with it?
- How do I invest if I have debt?
This comprehensive guide will answer these questions and more to help you build serious wealth now. My detailed action plan transcends theory with immediate steps to accelerate your path to wealth creation (regardless of where you’re starting from). You’ll see precisely how to evaluate savings and investment decisions at each “level” of the financial game.
Start with Level 1 and move to Level 2 when you accomplish the goal outlined in Level 1. Rinse and repeat your way up the staircase. Note that not all steps will necessarily apply to you. For instance, if you work at a company that doesn’t match your 401K, skip Level 2 and move right to Level 3.
Please also recognize that the younger you are, the more value this blueprint will provide. Time and discipline are an investor’s two greatest assets. We can work to improve your investing discipline, but your time horizon is simply a function of how early you start. Make today the day!
Level 1 – Build Your Emergency Fund
Your first goal is to save three to six months of living expenses in what’s called an Emergency Fund. This may sound a bit overwhelming, but let’s break it down into easy pieces.
First, take a close look at your expenses so you know what you’re targeting. You don’t have to build a complex budget or become a wizard in Excel! Just comb through your bank statements and credit card apps for the past couple months. Alternatively, you can use a free app like Personal Capital, and it will do all the work for you. (Note: CashSnacks.com will receive a bonus reward if users sign up using this link.)
Look closely at your expenses and go beyond what I call “surface expenses” which are top of mind items like food, housing, utilities, and transportation. Lurking below the surface you’ll find healthcare, storage facilities, gym fees, routine drug store trips, Spotify subscriptions, etc. Include these to arrive at your true average monthly expense amount.
Where to Stash Your Savings
After tallying your monthly expenses…start saving. Take your monthly average spend level, multiply that number by three to six, and set your savings goal within that range. Accomplishing this goal requires spending less than you make. It may sound simple, but this can be easier said than done depending on your income and lifestyle expectations.
Put these savings in an account that is highly liquid (meaning the funds are easily accessible) and secure. High yield online savings accounts are a great option here as well as money market accounts. These pay much higher interest than traditional bank accounts, and separating the funds from your daily checking account will diminish your temptation to spend them.
***If you have credit card debt or other high-interest loans, I’d still like you to save $500-$600 before moving to the next level. The reason is twofold: it provides an immediate cash cushion, and it’s a small win that will create momentum to help you build massive wealth down the road. We’re getting some of your cash, even if it’s just a few hundred bucks, working for you rather than against you.
Level 2 – Build Double the Wealth with Matching Contributions
Made it to Level 2. Let’s go! Emergency fund is all set. Now that we’ve built a little financial breathing room, let’s collect some free money.
That’s right, most large companies will reward you with “free” money just for investing in your future. This takes the form of what’s typically called a 401K match. There is no catch. You are leaving completely risk-free money on the table if you don’t contribute up to your match amount. I encourage you to consider this match as a very real part of your total compensation. Think about it. You wouldn’t pass up an automatic 5% raise that required zero additional effort on your part.
Not sure if your company offers a match or how large their matching contribution is? Swing by HR or give them a call. They would be happy to answer all of your questions. This is quite literally their job. They live and breathe this stuff.
The Power of the 401K Match
Now, you’re probably wondering exactly how this process works in practice. Let’s run through an example:
- Michelle emails HR and discovers her company matches 401K contributions up to 5% of her $50,000 salary
- With her emergency fund saved, she tells HR (or the 3rd party benefits provider her company uses) that she wants to contribute 5% of her salary to her 401K
- 5% of each paycheck will now be taken out (before taxes are incurred) and placed into her 401K
- Her contributions will total $2,500 (5% of $50,000) at year end, and her company will have added another $2,500 to “match” her contributions
Do you see the power of that?! Michelle got a 5% raise this year just for setting up her 401K optimally. Be like Michelle. Build your wealth with free money from your employer.
Investing Your 401K Contributions
The natural next question is how to invest your 401K contributions. Unfortunately, this will vary greatly depending upon specific options offered in your 401K plan, but here are a few rules of thumb:
- Look at expense ratios for every fund offered and try to choose the lowest ones available
- Search for broadly diversified, passively managed funds that track an equity index like the S&P 500
- Check if there are any “target date funds” that correspond to the year you plan to retire
- These may carry slightly higher expense ratios, but they automatically invest and reallocate your assets over time based upon when you plan to retire
Level 3 – Kick High Interest Debt to the Curb
Back to that high interest debt that we hinted at in Level 1. Let’s get that taken care of.
Before we get started, pay close attention to what I mean by high interest debt. This will likely consist of consumer debt that is carried on credit cards or something similar. Credit cards will often charge interest of 20% or more! It’s impossible to build wealth when you’re hemorrhaging this kind of cash. Time to stop the bleeding.
Defining High Interest Debt
So what exactly classifies as high interest? For my personal risk tolerance, I look at a 5% interest rate threshold. Anything above 5% interest will get paid down aggressively in Level 3. Debt below 5% interest (like many federal student loans) will continue to be carried with minimum payments made monthly. This is due to my belief that long term returns on my investments will exceed this rate.
There’s no hard and fast rule here. Maybe you’re more risk-averse and want to pay off anything with an interest rate above 3%. That’s great, get after it! The specific number isn’t what’s important. Rather, it’s the fact that you are cognizant of your debt and have created a framework to eliminate it.
Paying off Multiple High Interest Loans
How should you tackle multiple high interest loans at the same time? My recommendation is that after you make all minimum monthly payments, you allocate every additional dollar towards paying off the highest interest rate debt first. Prioritizing the highest interest debt ensures that you will pay the least total interest over the life of each loan. FYI, I didn’t make this idea up. It’s is called the Debt Avalanche Method. Let’s illustrate this with an example:
- Charlie carries a balance of $25,000 on a Visa and $15,000 on a Mastercard charging 23% and 18% interest, respectively
- He builds a bare-bones emergency fund and contributes up to the match amount in his 401K, if available
- He’ll make the minimum monthly payment on each card and use every spare dollar to pay down the Visa as quickly as possible since it is his highest interest debt
- Once he conquers the Visa, he moves on to the Mastercard
- He ultimately eliminates all of his high interest debt while paying the least amount of interest possible
For extra credit, feel free to check out the the godfather of getting out of debt: Dave Ramsey. He preaches an alternative strategy called the Snowball Method that has its own unique benefits.
Your Debt Paydown Mentality
I encourage you to re-frame the way you look at paying down debt. Think about it this way, paying down debt at a high interest rate (like 23% in our above example) means that you are guaranteeing a 23% return on your money. In other words, by avoiding an interest payment you are locking in a massive risk-free return on your money.
Considering that long term market returns hover in the 6-8% range after inflation, this is truly incredible. Keep in mind, this market return is far from risk free either. Just by paying down debt, you have the opportunity to secure a 20%+ risk free return immediately. The smartest activist investors and hedge fund managers in the world would be salivating at that opportunity. Run towards it and start paying down debt today!
Level 4 – Max out your Roth IRA
Alright, all of your high interest debt has been eliminated. Let’s keep up the momentum and put more of your money to work to build more wealth. We’ll do this through a flexible and tax-advantaged account called a Roth IRA. Since I know you’re just dying to know, an IRA stands for an Individual Retirement Account.
Unlike Level 2’s traditional 401K that was sponsored by an employer, a Roth IRA, as the acronym implies, is under your individual control. You’ll contribute money on an after-tax basis instead of having it deducted before taxes by your company. This means you’ll literally transfer cash out of your checking account each month when your direct deposit from work posts.
The Benefits of the Roth IRA
The powerful thing about this account is that although your money has already been taxed, once you place it in a Roth IRA it will never be taxed again. It can be left to grow and compound into a massive nest egg as you build wealth for years to come without every worrying about tax implications.
This is in contrast to a traditional 401K, where your initially tax-free contribution is taxed upon withdrawal in retirement. And the Roth definitely beats the double taxation you face in an ordinary brokerage account! With a normal brokerage account, you invest after tax dollars and any gains that you generate will be subject to additional capital gains taxes.
Additionally, a Roth IRA allows you to invest in any publicly traded security versus the set menu of options that your employer provides in a 401K. You are able to invest in cheaper and more diverse investment vehicles like ETFs and passively managed mutual funds. If you wanted to, you could even invest in individual stocks, but I don’t recommend this.
Finally, a Roth IRA offers unmatched flexibility as a retirement account. You are able to withdraw the principal (the intial amount you invest) at any time you would like. This gives you the tax benefits of a retirement account mixed with the versatility of a regular brokerage account.
Hopefully you’re beginning to understand why young investors should flock to Roth IRAs. It’s essentially a hybrid account that can be used for both 5-7 year savings goals (wedding, house, grad school) and retirement at the same time.
It is important to note that any gains on investments may be subject to taxes or penalties if withdrawn before retirement. Even here, however, the Roth IRA offers unique flexibility. Check out some of the special situations where gains may be used without penalty.
Creating and Investing in a Roth IRA
Remember, this type of account has nothing to do with your employer or HR. It is individual. You’ll head over to a brokerage firm’s website (Vanguard, Charles Schwab, Fidelity, etc.) and spend about 15 minutes entering your personal information to create an account. Then, you’ll link the Roth IRA to your regular checking account and transfer your money.
It’s that easy guys. These companies have spent millions of dollars to ensure that the sign up process moves as seamlessly as possible. Do this right now. Reach out if you don’t understand how, and I can even walk you through it.
The maximum Roth IRA contribution limit varies by year and income level, but it currently sits at $6,000/yr for many of my readers. Frustratingly, once your income gets high enough, you cannot contribute to a Roth IRA without jumping through an additional hoop. We’ll talk more about how to execute a Backdoor Roth IRA separately.
I could (and probably will) write an entirely separate post regarding my investing philosophy in a Roth IRA. In the meantime, the same rules of thumb that we talked about in Level 2 apply. Stick to broad-based, diversified, low cost ETFs / index funds. Some of my favorites include: VTI, VXUS, SPY, VOO, SCHF, SLYV, and SCHB. (In the interest of full transparency, I own VTI, VXUS, SCHF, SLYV and SCHB at the time of this writing.)
Level 5 – Increase Retirement Contributions Until You Max Out Your 401K
Noticing a trend here? Do whatever you can to minimize your tax burden by socking away as much money as the IRS legally allows in tax-advantaged accounts. Reducing your tax exposure may sound boring, but it’s one of the most powerful ways to build wealth. Even better, it doesn’t require altering your lifestyle like aggressively cutting expenses does.
Head back to the employer-sponsored 401K plan that we visited in Level 2. You’ll look to increase contributions until you reach the maximum yearly contribution limit if possible. Recall that you will have already allocated a set portion of your salary towards 401K contributions to receive your employer match.
Now that we’ve made it all the way to Level 5, reach back out to HR / the 401K administrator and tell them to raise your contribution level. How much can you raise it before reaching the contribution limit? The answer unfortunately depends on your unique situation , but the yearly limit for most of my readers will be $19,500/yr at the time of this post.
Example of Maxing Out Your 401K
To illustrate how this works, let’s return to our friend Michelle from Level 2.
- She has the grown her salary to $70,000 after working diligently and receiving a promotion at work
- 5% of her annual income has already been contributed to her 401K to continue taking advantage of the employer match (free money!)
- Notice that the 5% match is now worth $3,500 (5% of $70,000) since she’s grown her income
- After entering Level 5, Michelle contacts HR and informs them that she would like to increase her contribution level to ~28% of her annual salary
- This percentage is determined by dividing Michelle’s maximum 401K contribution amount by her annual salary ($19,500 / $70,000 = ~28%)
- Note that she could have also raised it anywhere between 5% and 28% depending on her current ability to save (while maxing out your 401K is the goal in Level 5, this doesn’t mean you should wait to make any changes until you can jump all the way to the maximum level)
When determining how to invest the additional money in your 401K, refer back to Level 2 once again. Luckily, if you set up your account correctly in the first place, most 401K plans will automatically invest the extra contributions based on your original asset allocation. The only difference is that you’ll be investing much more money by now, accelerating your potential to build wealth.
Level 6 – Save More Money and Invest in Real Estate
Starting at Level 5, and certainly in Level 6, your decisions and strategy will become much more personal. If you’ve made it here, you’re ahead of 95% of the world already. You’ll have to decide how you want to proceed based on your unique financial situation and risk tolerance.
Everything thus far has basically followed conventional financial wisdom. Level 6 is not conventional. It will likely raise some eyebrows and prompt some angry emails, but hear me out. Also, to be clear, I’m suggesting that you invest in real estate…not simply buy a house to live in.
Why to Invest in Real Estate
The full range of real estate investing benefits are beyond the scope of this post, but it is an extremely valuable tool once you understand even a small portion of its potential.
It boils down to a few key points. First, you’re able to invest with cheap leverage (or debt) through a mortgage. Second, you can have another person (your tenant) pay down this cheap debt for you which builds your equity. This increases your net worth. Additionally, if you invest properly, you will generate a surplus of monthly cash flow after paying down debt and all the expenses associated with home ownership. Real estate has the power to fundamentally transform your ability to build wealth at a young age.
There is much more to unpack, but I hope you’re beginning to grasp why real estate is such a compelling tool for investors. To reiterate, it’s all about using other people’s money to create more of your own. The magic lies in the fact that the money you borrow is paid back by others. Investing in real estate will also allow you take advantage of further tax benefits. And as we’ve discussed, avoiding taxes (legally of course!) is an absolute X Factor as you continue to build wealth. Check out this brilliant post from one of my favorite real estate investors, Chad Chad Carson, if you want to nerd out a little more.
How to Start Investing in Real Estate
There are almost limitless ways to make money in real estate, but I’ll focus on two solid starter strategies here: “House Hacking” and buy & hold rental property investing.
House Hacking
House Hacking is a phenomenal way to get your feet wet as a first time real estate investor. It’s a hybrid between an investment and a personal home purchase. The idea is to buy a single family house or small multifamily property and live in one of the rooms / units while renting out the remaining space. Since this will function as your primary residence, the bank will offer very attractive terms on your mortgage. You’ll also gain valuable experience as a landlord and live-in property manager that will serve you well across future real estate endeavors.
Done correctly, house hacking enables you to live for free or even generate a cash flow surplus while simultaneously increasing your net worth through the equity you build. Experts typically recommend spending no more than a third of your income on housing expenses. Imagine the power of completely eliminating this massive expense while also building equity. It’s like all the benefits of moving home to your parents’ place…without fear of getting yelled at when you forget to take out the trash. The best part is that you can invest all of these additional savings in other opportunities without drastically altering your life.
Buy & Hold Rentals
Another strategy is investing in a traditional small buy and hold rental property. While you won’t get mortgage terms that are quite as favorable or eliminate your housing expense, you also won’t have to live with your tenants. Ideally, you want to start investing in an area that you know well. This could be where you currently live or where you grew up or simply a place that you have a strong network.
This strategy will take a ton of hustle and research, but it can pay off handsomely, especially the earlier you start. It appeals to many of my readers who move to high cost cities like New York or San Francisco after school. The barriers to entry and competitive nature of these real estate markets make it extremely difficult to get started. By taking advantage of your network and insider knowledge in other areas, you can find better opportunities to build serious wealth.
A Word of Caution
Now that you’re sold on investing in real estate, let’s inject a small dose of reality. Level 6 is for the absolute hustlers looking to truly accelerate their path to wealth. It is not something to jump into without a foundational education and the right mindset.
To get started, learn how to analyze a deal and boost the odds of getting your offers accepted. I also encourage you to poke around Bigger Pockets. This site does a great job covering every angle of real estate investing. The forums provide a great way to meet like-minded investors in whatever geography that you’re targeting.
For now, I’ll just leave you with a few cautionary thoughts. With the investments that we’ve discussed in previous levels, the most effort you’ve exerted has been clicking a couple buttons on a website or perhaps making a phone call. In real estate, you’re dealing with real people, repairs, liability, evictions, and much more. The payoff may be massive for those willing to put in the effort, but there is no shame in skipping Level 6 entirely!
Level 7 – Dealer’s Choice
We made it baby! Level 7. Congrats on getting called up to Big Leagues. Here’s where life becomes a lot more interesting. Your money management might even start to get a little…fun?
You have a ton of different options to play with depending on individual risk tolerance. If you want to double down on equities, open a taxable brokerage account at the same place that you set up a Roth IRA in Level 4. You might continue to invest in highly diversified, low-cost ETFs / index funds. You might prefer to build a large cash position that you can deploy when the stock market crashes. Alternatively, you could consider investing part of your portfolio (say 5-10%) into ETFs that focus on alternative asset classes like gold / precious metals, REITs, or bonds to create enhanced diversification. This path would likely reduce your overall risk exposure without compromising much of your upside.
Again, it’s important to remember that with each successive level that you climb, your strategy should grow more tailored to your individual goals and investing style. Level 7 is an open book.
When I began my journey, I initially invested excess money more heavily in equity funds out of a taxable brokerage account. Later, I discovered the power of real estate and shifted my focus to saving money for the aggressive pursuit of real estate acquisitions. Level 7 is all about keeping an open mind and seeking interesting opportunities to learn and grow.
Wrapping Up
And that, ladies and gentlemen, is how to use your 20s to build life-changing wealth. If you follow this blueprint, I can’t tell you exactly when or how you’ll create your wealth. But, I can guarantee that in the not-so-distant future you’ll be staring at a net worth figure that will make your jaw drop. Keep at it and remember to enjoy the ride!