Financial Planning Basics

By HonestFinance | Updated July 18, 2018

Financial Planning Basics

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The Basics

Personal finance can seem daunting and complicated, but it's much easier than how the industry portrays it to be.

Luckily we are here to help. Our goal is to simplify unnecessary financial jargons and provide unbiased information to help you make easier financial choices.

Of course, there are complex financial situations that may require expertise and outside help. But complicated situations can be avoided by starting in the right direction and setting a solid foundation.

First, start with The Six-Step Financial Planning Basics below, then branch out to other pages on our website to learn and implement more in-depth financial topics discussed in the six-steps.

*Please remember that this guideline applies to typical salaried workers and may not be suitable for everyone.*

The Six-Step Financial Planning Basics

  1. Build up an Emergency Fund
  2. 401k Employer Match
  3. Pay off Debt
  4. Max out Traditional IRA or Roth IRA
  5. Max out 401(k)
  6. Invest and/or Payoff Low-Interest Debt

1. Build up an Emergency Fund

Build your emergency fund as quickly as possible to protect yourself and your family from unexpected events.

What will happen if you were suddenly laid off without notice (Yay Corporate America!) but you don't have any accessible funds in place to pay for rent and avoid getting evicted?

Prepare for these types of situations by quickly saving at least three months of your after-tax take-home pay.

If you're an hourly worker or a business owner with fluctuating income each month, average from the previous three months of earnings.

Saving three months of take-home pay is no walk in the park, but it's possible by going through a rigorous budgeting process.

2. 401k Employer Match

Contribute up to the employer matching percentage in your 401k. If your company does not provide matching benefits, please skip to step three.

But you might be wondering, why does this step take precedence over paying off debt and other financial objectives?

The benefits too significant to ignore. The employer contribution is technically free money that can be invested with tax advantages. Besides, companies usually only match up to only 2%-5% of your salary, meaning you are only committing 2% - 5% of your salary which shouldn’t have a dramatic impact on your overall finances.

So unless you need every cent to make sure your bills are paid, we highly recommend taking the 401k employer match benefit by making small contributions.

3. Pay off Consumer Debt

Debt could be a detriment to your finances if there is no clear strategy nor any intentions to pay ever pay it off. For many people, they accept debt as part of their life and will end up paying hundreds and thousands of dollars in interest. You must work hard to get out of this lifestyle and become debt free as quickly as possible.

But this is much easier said than done. We recommend reading How To Pay off Debt to fully understand what qualifies as Consumer Debt and to implement an effective repayment strategy.

4. Max out Traditional IRA or Roth IRA

Start maxing out a Traditional IRA, Roth IRA, or a combination of both. If you're within the income limit, you can contribute up to $5,500 or $6,500 annually if you're over 50.

Although it's tempting to spend or invest the money elsewhere once you have established an emergency fund and paid off consumer debts, preparing for retirement should take precedence.

Again you might be asking, why Traditional IRA or Roth IRA before maxing out rest of my 401(k) beyond employer contribution? In most cases, 401(k) have higher administrative fees and has less variety of funds compared to Traditional/Roth IRAs.

Learn more about the differences between Traditional IRAs, Roth IRA, 401(k), vs Roth 401(k) and see which retirements accounts might be most suitable for you.

5. Max out your 401(k)

Once your Traditional IRA or Roth IRA is maxed out, now try maxing out your 401(k).

Again, prioritize retirement. It's so easy to get sidetracked and start putting your money somewhere else.

"But you just said 401(k) have small investment selection and has higher costs." True, but like Traditional/Roth IRAs, 401(k)s feature tax-exemption benefits and impose penalties that discourage you withdrawing from your retirement funds.

6. Invest or Pay Off Non-Consumer Debt

You've completed the essential steps and should be in a healthy financial position at this point. But this doesn't mean you should completely take your foot off the pedal and de-prioritize saving and increasing your net-worth.

Continue investing outside of your retirement accounts, pay off your non-consumer debt, or a combination of both.

For some, investing rather than paying down a low-interest debt like a mortgage makes sense given the average market returns. But for others, they understand market returns are never guaranteed while paying off debt guarantees the interest cost savings.

Now that you are aware of financial planning basics, now it's time to take action. The earlier you implement these steps, the better off you'll be in the long run. So don't hesitate and start taking control of your finances as soon as possible.


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