Let’s face it: 2020 wasn’t friendly to our plans. From travel plans to the weekly routines of evenings out with friends, many people found themselves holding onto money they would have otherwise spent.
With that decreased spending, many Americans who didn’t need the money to make ends meet started stashing their cash in savings accounts. Data from the Federal Reserve Bank of St. Louis shows that between February and April 2020, savings balances increased about 7.1%. That’s compared to the 1% month-over-month increase during the same time period in 2019.
As the pandemic continues into 2021, it’s worth considering how to make that extra cash work harder.
Financial planner John Bovard of Incline Wealth has heard this question over and over again in early 2021. “In talking to my clients during year-end reviews … what came up from all but one of them was, ‘What should I do with the extra cash that I have?'”
Here’s the answer he’s been giving to his clients.
Start by filling up your emergency fund
Before investing that money, Bovard suggests doing a few things first.
Many of his clients have already have filled up and topped off their emergency funds. But, a full emergency fund should be a first step for anyone who doesn’t yet have one. Generally, financial planners suggest saving between three and six months’ worth of expenses in a savings account.
Then, pay off credit card debt
After that’s accomplished, he recommends turning to credit card debt. Paying off credit card debt or any high-interest debt should be prioritized over investing.
Increase your 401(k) contribution
After credit card debt, Bovard recommends making sure you’re getting the maximum match on your 401(k), if available. A match is essentially free money from your employer, but it’s only available if you put in enough cash. Double check to make sure that your contribution is high enough to take advantage of the full match before investing outside of your 401(k).
Fund a Roth IRA
For anyone who doesn’t yet have a Roth IRA, opening one might be a smart way to stash the extra money you saved in 2020.
A Roth IRA is easily funded with money you’ve already paid taxes on, and can be opened through a number of banks and online investing services. One of their big advantages is that money grows tax-free for retirement, allowing you to keep more of your money later. Anyone under age 50 is allowed to contribute up to $6,000 per year to these accounts, or $7,000 if you’re over 55.
Bovard suggests investing in a Roth IRA before a general taxable investing account for two reasons. “I like the Roth IRA, firstly because of the tax treatment. Secondly, because in an emergency you could get out what you put in,” he told Insider by email.
Set up an automatic investing deposit
After ticking off all the above steps, Bovard suggests taking investing one step further by setting up an automatic, recurring deposit. “I love automatic monthly contributions into a brokerage account. This can be one of the single easiest ways to build wealth over the long term,” Bovard says.
While the markets have faced extreme ups and downs during the COVID-19 pandemic, putting money into the market steadily over time can help smooth out those extremes. This strategy, called dollar-cost averaging, is a favorite among financial planners. It involves steadily investing the same amount of money over time. “Setting this up as a monthly contribution that is automatically invested is the best way to do it,” he says.
A secondary benefit to setting up these deposits is that they’ll continue indefinitely and effortlessly, even when life goes back to normal. “If the money is automatically deposited, it is in the account before it can be spent, and this allows for the magic of compounding returns over time,” he says.
Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.