Waterfall Approach to Money Management

Taking a page from project management methodology, the Waterfall model follows a step by step flow that moves in one direction through phases of a project to reach the end with the desired result.  The project cannot move to the next stage until each preceding stage is complete.  Any changes that alter a prior stage's results trigger a set back and the project must return to the unfinished stage before moving forward again.  This same approach can be applied to money management with the end goal being debt free with a fully funded nest egg by the time the investor is ready to retire.  While some of these steps can be run in parallel, following this flow of priority will help investors reach their retirement goals with less worry.

1. Get insured - Nothing can ruin a financial plan like unexpected medical bills and/or a loss of an income earner's salary due to death or disability.  Even if funds are tight, having a high deductible health insurance plan to protect from catastrophic losses and a basic term-life insurance plan can both be affordable.  Without insurance, a simple accident or illness can push back retirement by years.  A major illness or accident for someone uninsured can push a family into bankruptcy and ruin the chance of ever retiring.  Life insurance protects loved ones' quality of life.
2. Pay off short-term debt - This stage is building the foundation for all future years of money management.  This stage is not focused on elimination of long-term debt such as a home mortgage or college loan, but more so high interest short-term debt such as credit cards that charge higher interest rates than an investor can expect to earn from reasonable investments.
3. Create savings account - A savings account or "emergency fund" is a crucial early step in money management, but starting one before short-term debt is paid off defeats the purpose.  The main reason to have a savings account not invested in volatile assets is to avoid incurring short-term debt such as carrying a credit card balance.  Too many savers prioritize this step before paying off short-term debt and needlessly pay interest on debt that is much greater than the interest they earn from their savings account.
4. Invest in a qualified retirement plan (401(k), 403(b), IRA, etc) - Too many people who do not have an emergency fund end up borrowing from their 401k which hurts them long-term.  This is why investing in a retirement plan should follow the funding of an emergency account.  Tapping into the emergency fund when needed instead of making an early withdrawal from a qualified retirement plan will save the investor from incurring early withdrawal penalties and will keep retirement plans on track.
5. Invest in taxable brokerage account - After a good foundation is in place that includes no debt, an emergency fund and a maxed out retirement account it is time to focus on growth.  Investing in a taxable account gives investors a better cushion if plans do not play out as expected and can lead to a possible earlier retirement when plans do not hit roadblocks along the way.  If someone is not interested in retiring early, a taxable brokerage account can be used to save for a larger expense farther down the calendar, such as a vacation home.
6. Pay off auto loans - Depending on the interest rate for the vehicle, this might need to come before creating a taxable account.  Lower fixed expenses open up the doors to saving more in accounts that pay interest rather than debt that receives interest from the investor.  Investors are better able to handle economic changes such as a job loss or income reduction when fixed expenses are reduced or eliminated.  When recessions hit, those who have low fixed expenses and a fully funded emergency account fair better and have less stress while managing the economic changes.
7. Pay down home mortgage - Investors should reduce fixed expenses as much as possible before retirement.  Writing off mortgage interest on a tax return is not as beneficial as not having the expense to write-off in the first place.  Keep in mind - this is not a tax credit.  This write off only saves a taxpayer 25-35% of what they've paid.  That leaves 65-75% of a wasted expense of interest paid out.

Investors who have lower fixed expenses during retirement do not need a nest egg that is as big and are more likely to be able to pass down more to family members as inheritance.  Following this waterfall process flow will help investors reach this goal.