The Financial Order of Operations

Version 1
November 2020
Table of Contents

• The Most Common Question in Personal Finance

• Just Like Math’s Order of Operations
• The Basics – 10 Steps
• The 10 Steps Explained
• The Detailed Flowchart
• …And Now What?
The Most Common Question in Personal Finance

• “I got a big bonus! Now what?”

• “I have leftovers from my paycheck. What smart things can I do?”
• “Should I invest? Pay down debt? Save for a mortgage?”

All these questions are answered using

The Financial Order of Operations
Just Like Math’s Order of Operations

• When you’re facing a math question, you employ PEMDAS—the

mathematical order of operations

Source:
TheCalculatorSite.com

• Personal finance has its own version. It tells you the order should you
solve your money problems.
The Basics – 10 Steps
There are 10 basic steps in this order of operations…

1. Create a budget
2. Build a small emergency fund
3. Pay off high interest debts
4. Maximize employer matching on retirement funds
5. Build a 3-6 month emergency fund
6. Pay off "mid" interest debts
7. Max out Roth IRA, HSA (or similar)
8. Max out 401k (or similar)
9. Pay off "low" interest debts
10. Prepay future expenses
The 10 Steps Explained
But let’s go into a little more detail on each step…

1. Create a budget
• A budget is your financial baseline. It allows you to understand three things:
• How much money you have right now.
• How much income you’re getting
• How much of that income you’re spending
• Click to follow: How experts budget
2. Build a small emergency fund
• An emergency fund is money that just sits in your bank account, waiting for an important reason (an
emergency!) to use it
• At this level, your emergency fund should be big enough to cover your insurance deductibles. You
need to have money to cover your healthcare, car repair, or home repair before your insurance kicks
in.
• Typically, this is around $1000
• Click to follow: An example of why an emergency fund is important.
The 10 Steps Explained (cont’d)
3. Pay off high interest debts
• “High interest” is typically defined as 8% interest rate, or higher.
• Example: credit card debt (typically ~20%)
• Debt is like a leaking bucket—you just sit there and your money disappears. Before you fill up
the bucket anymore, first you need to fix the leak!

4. Maximize employer matching on retirement funds

• Some employers will offer free money as a employee benefit. The catch is that you only receive
the free money if you choose to invest in your retirement accounts—like your 401(k)
• Get as much free money as you can!
• Click to follow: How I Invest in my retirement accounts
5. Build a 3- to 6-month emergency fund
• This is like Step 1, but bigger. Build up that emergency fund so it could cover your living
expenses in the event of an unexpected loss of employment.
The 10 Steps Explained (cont’d)
6. Pay off "mid" interest debts
• “Mid” interest debts are typically in the 6% to 8% interest rate range.
• You could invest money in the stock market—and you’d expect an average return of about 7%
(source). Or you could just pay off these mid-interest debts and guarantee a 6-8% return.
7. Max out Roth IRA, HSA (or similar) accounts
• The government offers you a sweet deal: if you save money for later, they’ll give you a
tax break. The Roth IRA and HSA accounts are generally considered the optimal tax-
advantaged accounts.
• Click to follow: Why long-term investing takes faith…
8. Max out 401(k) account
• After you get all the “free money” you can in Step 4, this step rounds out the benefits
of your 401(k)
• Similar to Step 7, this step ensures you get the biggest tax break you can.
• Click to follow: But what about market crashes?
The 10 Steps Explained (cont’d)
9. Pay off "low" interest debts
• “Low” interest debts are typically 6% interest rate or less.
• Some student loans, most mortgages
• The idea here: an average 7% rate of return in the stock market is better than preventing a 6%
(or less) loss by paying off a low interest debt
10. Prepay future expenses
• You might be saving up for a house or for retirement
• You know someday you’ll need a new car, to pay for kids’ college, etc.
• Spending will happen – why not save for it now?
• Click to follow: what about the “unknown unknowns?”
The Detailed Flowchart
If the 10 Steps feel a little incomplete, then the flowchart on the next few pages should fill in the gaps.

The color scheme of the boxes link back to the flowchart as follows:

2) Build a small 5) Build a 3-6

1) Create a emergency 3) Pay off 4) Max out
month
budget & pay fund, then pay high-interest employer
non-essential
emergency
essential bills debts matching
bills fund

8) Max out
6) Pay off 7) Max out 9) Pay off 10) Prepay
401(k), 403(b)
mid-interest IRA & HAS low-interest future
or similar
debts accounts debts expenses
accounts
 Create a budget Pay rent or Buy Food & Pay for Essential
Know where you money is mortgage Groceries Utilities
going.
How much comes in? Keep a roof over Keep a roof over
Power, water, heat
How much goes out? your head your head

Build a small Pay for “Income

Minimum Pay for
emergency fund Earning” Expenses
Payments Healthcare
The things that allow you
Typically either $1000, or Pay the minimum on all
Typically insurance to earn money (like gas
One month’s of expenses your debts and loans
for your commute)

Pay them down!

Pay non-essential bills Do You Have
Debts at 8% There’s a monkey
Yes
Stuff like Netflix, your cell Interest Rates, sitting on your chest,
phone, gym membership or Higher? stealing your
bananas!
No

The Detailed Flowchart

Slide 1
 Does Your Employer Maximize the full
Offer a Retirement employer match
Account (e.g. 401k) with Yes
It’s free money!
an employer match? Get as much as you can.

No
Build Your Emergency
Pay them down!
Do You Have Debts in Fund to 3-6 Months’
Yes the 6-8% Interest Expenses
There’s a monkey
sitting on your chest, Rates Range?
stealing your bananas! If you lose your job, you need
funding until you find a new one.
No

Save and Prepay

Those Expenses
Are You Expecting a Yes
Big Expense in the If need cash soon, start
Near Future putting that cash away
No
New house, new car, kids The Detailed Flowchart
going to college Slide 2
 Max out your Health
Savings Account (HSA)
Max out your Individual
This is only offered with High Retirement Account (IRA)
Deductible Health Plans

Don’t worry if you don’t qualify…it Evaluate whether you’d rather have a
probably means you’ve got a good Roth (post-tax) or Tradiational (pre-
health plan. tax) IRA

Save and Prepay Future Expenses Do You Have Any

Remaining Debts? Max out your Employer
New car? New house? Retirement Account
Savings for kids’ college?
At this point, they should be 6%
Invest extra for retirement?
interest or less
Such as 401(k) or 403(b)
You know you’ll need money in the future, so
Pay them down!
why not start saving now?

The Detailed Flowchart

Slide 3
…And Now What?
Now that you’ve mastered the order of operations, what’s next?

1. I recommend setting some simple financial goals!

2. Are you on track? See how your net worth compares to your age group.
3. Not where you want to be? Start with baby steps. Use this calculator to set a savings goal
for the next year!

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Best,
Jesse Cramer
Founder, The Best Interest