Financial Order of Operations by The Money Guy Show
The Financial Order of Operations was created by the folks at The Money Guy Show. It’s offered as a free download (in trade for an email address) and a course. The FOO is presented much like mathematical order of operations and consists of nine steps.
Each successive step builds on (read requires) completing the previous step. So, if you’re maxing out the tax-free accounts (step 5) and your emergency reserves are below where they should be (step 4), you go back to step 4 and stop maxing out the tax-free accounts (or reduce how much you’re putting toward them).
Deductibles coveredSection titled Deductibles covered
The first step is about having enough cash to cover any deductibles required by insurance you may carry.
Let’s say your car insurance has a deductible of 1,000 USD, medical is 2,500 USD, and home owner’s (or renter’s) is 500 USD. In total, to complete this step, you would want 3,000 USD in cash; earmarked for deductibles, not other expenses.
Employer matchSection titled Employer match
The second step is to contribute to an employer-sponsored retirement plan at a high enough percentage that you reach your employer match. If your employer doesn’t offer a retirement plan or a match, you can skip this step. With that said, it may be worth considering negotiating a higher salary or finding a different employer.
Let’s say your employer offers a 401k plan with a 5 percent match. To complete this step, you would want to be contributing at least 5 percent of your gross pay to that plan.
Note: Retirement plans such as the Traditional 401k comes with the added benefit of reducing your taxable income.
High-interest debtSection titled High-interest debt
The third step is paying off high interest debt. High interest debt is somewhat subjective though. In general the idea is that if the interest is higher than the yield (dividends) of saving or investment accounts, it’s high interest.
In a few episodes the hosts do discuss age-based determinations.
Once you are no longer carrying a balance on high-interest debt, you can move on to the next step.
Emergency reservesSection titled Emergency reserves
The fourth step is building up cash for emergencies. Emergencies are separate from cash flow (your regular expenses like food) and deductibles from step one. In the extreme case this is referring to loss of employment or income.
Most folks recommend 3 to 6 month’s worth of emergency reserves, The Money Guy crew discuss this in terms of your total lifestyle cost and your ability to get re-employed. If you have a high total lifestyle cost, which would require a high rate of income, and it may take a long time for you to become re-employed at that rate, you may want to have a larger emergency reserve (may be in terms of years). If, however, your total lifestyle cost is low and you can easily find employment making that much, then your emergency reserves could be in terms of weeks; not months or years.
Once you have this step complete, then it’s time to move on to step 5.
Note: If the emergency happens and the emergency reserves no longer covers you, you come back to step 4. Further, if your total lifestyle cost increases, you come back to step 4.
Roth and HSASection titled Roth and HSA
Roth and HSAs are considered tax-free, which means you aren’t taxed on the growth and aren’t taxed on the withdrawals. With that said, the drawback is that the money you’re putting in is taxed at your regular income tax rate. It’s worth noting that Roth style accounts are sometimes available beyond the IRA variation where they started.
There is a maximum amount per year you can contribute to these accounts. This step of the FOO is about reaching that maximum.
If you don’t have a medical plan that allows for an HSA, no worries; open a Roth IRA account or see if your employer offers a Roth 401k option.
Max-out retirementSection titled Max-out retirement
The sixth step is about reaching the maximum you can contribute to your employer-sponsored retirement accounts.
Similar to IRAs and HSAs there are annual contribution limits for employer-sponsored retirement accounts. And here there’s some wiggle room, again, guardrails.
Up to this point, we’re looking for a target savings rate of 25 percent of your gross income. So, if you make 20,000 USD per year, if you’re saving and investing 5,000 USD per year toward all of the steps up to and including this one, you can move on to the next step. This was mentioned in the August 17th, 2022 episode of the show.
The idea here is that some folks do not earn enough money to actually hit over 20,000 USD in their 401k, another 6,000 or more USD in their Roth IRA, and another 3,000 or more in their HSA; you would need to make at least 30,000 USD per year to do that and some folks simply aren’t in a position to put all that toward investment accounts and still live.
So, the higher-order goal is a savings rate of roughly 25 percent up to this point. Once you do that, then start looking at the other steps.
Hyper-accumulationSection titled Hyper-accumulation
The seventh step is where you start saving and investing outside of the tax-advantaged accounts in the previous steps. This is in addition to, not in replacement of.
While this could be in regular guaranteed savings vehicles like savings accounts, money market accounts, certificates, and so on, it’s usually recommended that you have a taxable brokerage account to invest in things like equities, bonds, mutual funds, and so on.
At this point, you’ve secured your mask enough to feel confident you will be able to reach financial independence when you want to. Once that happens, this step is complete.
Pre-paid future expensesSection titled Pre-paid future expenses
The eighth step is about setting aside money for things other than retirement; a child’s future college expenses, for example—possibly using a 529 plan.
Once you have pre-paid those future expenses—usually for other people—you can move on the next step.
Low-interest debtSection titled Low-interest debt
The ninth and final step is when you concentrate on paying off low-interest debt.
In general, Brian Preston (The Money Guy), does put a relatively hardline in the sand stating: By age 50 to 55, you shouldn’t be carrying any debt.
Read my personal reflections on The Financial Order of Operations