Cryptocurrencies are incredibly popular right now — so much so that many people are investing a lot of money into them without knowing exactly what they’re doing.
So whenever anyone asks me if investing in bitcoin or any other cryptocurrency is a good idea, I just have one question for them: What does the rest of your portfolio look like?
That’s because if you jump into investing in crypto without having a solid foundation for your personal finances, you’re going to have a bad time.
In fact, there are five areas that you should focus on first before jumping into cryptocurrencies:
- Paying off your debt
- Maxing out 401k match
- Contributing to a Roth IRA
- Creating an emergency fund
- Automating your personal finance
Let’s take a look at each area now, and break down how you can approach it.
Get out of debt
Debt is the biggest barrier to a better financial future. 80 percent of Americans are straddled with debt in some form or another.
That’s why eliminating your debt fast should be your first priority — and there are a number of ways you can do it.
First, you can pay the minimum on all of your debt, but pay more on the loan with the highest APR since it’s costing you more each month. You’ll end up saving more money if you’re able to get rid of it first.
You can also utilize the “Snowball Method” of getting out of debt. This works by paying the minimum on all your debt, but paying more toward the loan with the lowest balance first. This allows you to pay off debt more quickly.
This isn’t the most efficient way of getting rid of debt — but it offers a huge psychological reward to see a debt being paid off.
401k: Free money from your job
A 401k is a fantastic investment account offered by most companies to their employees. It works by investing your pre-tax income as well as a 1:1 match from your company.
This means you’ll be able to invest even more money into a 401k than you would a typical investment account.
Let’s say your company offers a 5 percent match and your income is $100,000 a year. If you invest 5 percent of your salary ($5,000) into the account, your company will match you that exact amount. Of course, you can always invest beyond the match. As of 2018, the contribution limit for a 401k is $18,500.
When you invest in a 401k, your money is managed by a professional investment company. They will likely offer you a variety of investment options to choose from based on your age and risk tolerance.
Once you leave your job, you can roll your money into a Traditional IRA, where it’ll continue to grow if you invest it.
Remember: This is pre-tax. You will be taxed on the money when you withdraw it at retirement age, which is 59 ½ years old.
Roth IRA: The most powerful investment vehicle
If you want to invest your after-tax income and not be taxed when you retire, you’ll also want to invest in a Roth IRA.
This means you can take the paycheck you receive each month and invest a portion of it into stocks, bonds, or other assets, and pay no taxes when you withdraw it at retirement age.
As of 2018, the contribution limit for a Roth IRA is $5,500 if you’re younger than 50 years old and $6,500 if you’re older. So you won’t be able to invest as much as you could in a 401k — but with compounding, you’ll still make a lot of money.
Also unlike a 401k, you’ll have to open up the Roth IRA yourself. Luckily, doing so is simple. You just have to find a good brokerage and open an account. A few I suggest are Charles Schwab, Vanguard and E*Trade. Once you open an account, you’ll have to choose your own investment options.
Create an emergency fund
Your emergency fund acts as a financial parachute during the worst-case scenario. If you ever lose your job, the economy tanks or you need medical treatment, an emergency fund can help support you and your family during those trying times.
A good rule of thumb for creating your emergency fund is having three to six months of living expenses put away. This is enough money for things like your rent, mortgage, car payments, bills and groceries.
Remember: You’re probably going to have to make some sacrifices while you live off of your emergency fund — especially if you experienced a loss of income.
This means you’ll have to stop getting Uber rides, cancel your Netflix subscription and get rid of your gym membership.
However, you can factor all of those things into your emergency fund savings goals. That way you don’t have to sacrifice your lifestyle during the down times.
And there’s one method I suggest for creating your emergency fund that’ll help you save for it painlessly:
Automate your personal finances
Automating your personal finances is a better alternative to traditional budgeting.
Here’s how it works: When you receive your paycheck at the beginning of the month, your money is immediately sent to where it needs to go through automatic systems that you’ve already set up.
Here’s where your money could go:
- 50 percent - 60 percent to fixed costs: This includes things like utilities, rent, internet, and debt.
- 10 percent to investments: This includes your Roth IRA and 401k plan.
- 5 percent -10 percent to savings: This is money that goes towards things like vacations, weddings, home down payments and unexpected expenses.
- 20 percent - 35 percent to guilt-free spending: Fun money! Spend this on anything you want from nice dinners to movies.
Once you automate your system, you only have to spend one hour each month to make sure everything’s in order. The best part: You no longer have to skip your morning lattes or lunch at your favorite deli to save money.
If you’ve gotten this far, congrats! You’re ahead of 99 percent of your peers. Now you can begin to put your money in alternative investments like stocks that interest you or cryptocurrency, using 5 percent of your income. It’s your money. You’ve earned it.
Once you get your financial foundation in place, you can start investing in things like bitcoin and smile knowing you’re well on your way to living a Rich Life.
For more tips on investing, check out Ramit Sethi’s I Will Teach You to Be Rich, where he’s helped millions of people with their personal finance and development.
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