Savings Waterfall

I always joke around with my friends that although I’m 27, on the inside I’m much older. I’ve been hearing about this reddit thing for a while now. One of my previous roommates would always peruse it and giggle to himself, so I thought it was just funny posts and memes. The other day I followed a link on Twitter to reddit. It was a story about a 22 year old who was making $100k a year and couldn’t figure out why he was in debt and living paycheck to paycheck. Of course there were some pretty harsh comments, but for the most part everyone was giving him sound financial advice such as use Mint to track your expenses, trim the fat, pay down the debt, etc. I was quite impressed with the help these complete strangers were giving this guy who bared all to get his financial house in order.

After reading this feed of strangers helping a individual get his financial life in order, I decided to poke around reddit some more… and then I was hooked. My favorite subreddits are obviously r/personalfinance and r/financialindepedence. I highly recommend taking a spin through both of them. While doing so I found that Justin at Root of Good and Mr. Frugalwoods are avid commenters.

What I found great about reddit is that the posts and comments get voted up and down by other users, so by natural selection the “better” posts and comments float to the top of the page.

One of the great takeaways I got from binge reading reddit was this great savings waterfall. I think it is great and an easy introduction to those new to personal finance.
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So I decided to walk through the waterfall and see how I tracked against the recommendation.

  1. Emergency fund – I currently have 3 to 6 months of expenses in a liquid online savings account yielding 0.99% APY. Check!
  2. Contribute to 401k up to company match – My contribution percentage will ensure I max out my 401k in 2015, therefore I definitely get the full employer match. Check again!
  3. Pay down high interest debt – The only debt I currently have is student loan debt at 3%. I’ve paid off all my student loans that were 4% and higher, so I consider this a win as well since I am choosing to milk this lower interest rate and pad my investments.
  4. Max out IRA – I will max out my Roth IRA this year. I kind of broke the path of the waterfall since I contributed to my 401k more than required to get the match before opening an IRA. I did this for two reasons, first my 401k plan through work only charges a $40 annual administrator fee whether you have $1 in it of $1 million, and second the plan is with Vanguard. Most people like to open an IRA before maxing out their 401k for more investment options and cheaper fees, but it was a wash for me.
  5. Max out 401k – Check! This will be the first year I do it though… better late than never!
  6. After-tax savings/investments – I definitely broke this rule of the waterfall. When I turned 18 I started a brokerage account and would buy some individual stocks from time to time up until recently. Now that I have become a self proclaimed Boglehead* I don’t plan on contributing to this account anymore. I will contribute any monies left after maxing out my retirement accounts to my Vanguard account and stick to low fee Vanguard index funds. If jlcollinsnh didn’t convince me before, reddit, Bogleheads, and a podcast interview with Rick Ferri** did. I don’t know if I’ll divest from all my individual stocks, but no new capital will be deployed to them going forward.

Do you enjoy the personal finance and financial independence community on reddit? What do you think of the savings waterfall? Do you follow the steps?

* – A Boglehead is a term intended to honor Vanguard founder and investor advocate John Bogle, and are investing enthusiasts who participate in the Bogleheads Forum.
** – Here is the Masters in Business podcast episode where Barry Ritholtz interviews Boglehead Rick Ferri. I highly recommend it.

39 thoughts on “Savings Waterfall

    1. Fervent Finance Post author

      Definitely takes a lot of the back and forth / indecision out of our savings process!

      Reply
  1. Jason@Islands of Investing

    That savings waterfall is a great, easy to understand diagram. I guess the only problem for many people is that there’s a giant ‘spending dam’ blocking the flow down that waterfall! I don’t follow this perfectly, as I find putting money straight into investments a little more rewarding.

    Have never checked out any of the posts on reddit, I’ll follow your links there now and have a read!

    Cheers,

    Jason
    Jason@Islands of Investing recently posted…The Winds of Change are blowing across the IslandsMy Profile

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    1. Fervent Finance Post author

      I guess if you don’t have your expenses locked down this diagram is pretty useless since you have no money leftover after “paying the bills”. I think of locking down your expenses as “patching the holes” in your boat before getting to the waterfall 🙂

      Reply
    1. Fervent Finance Post author

      I was shocked by the great information on reddit. They have so many great links for beginners and it seems like everyone loves their Vanguard index funds!

      Reply
  2. amber tree

    Hey FF,

    excellent visualization of the waterfall approach to saving and investing.After seeing it, it came clear to me what I do every year. I think I will make mine explicit as well, but adapted to the Belgium situation.

    Also noce to find another boglehead blog. I will follow up and see how you get along.

    thx for sharing this!

    Amber Tree

    Reply
    1. Fervent Finance Post author

      True – this is only applicable for the US, but definitely can be replicated elsewhere with some tweaks for the retirement accounts. Thanks for stopping by Amber Tree!

      Reply
  3. Andrew@LivingRichCheaply

    I think I followed the same path as you with regards to the savings waterfall…except I’m a little older. Kudos to you for maxing out your 401k and IRA. We’re still trying to get there but we definitely ramped it up recently. I don’t have a match with my 457 plan but the plan has many Vanguard choices with low fees and actually Admiral shares so I’ll take that! I do also have a pension (which can be a bit of a golden handcuff to my job). Some in the early FI boat aren’t big fans of the Roth since I guess you’ll have years to rollover so there’s that. I’m also a big boglehead fan…though I admit that sometimes I do have the urge to buy individual stocks but it’s only a small portion of my portfolio.
    Andrew@LivingRichCheaply recently posted…Going from Ordinary to ExtraordinaryMy Profile

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    1. Fervent Finance Post author

      Age is only a number Andrew! It’s great when your 401k or 457 is with Vanguard, then you at least know your employer is doing one thing right 🙂 I also intend on writing an article about keeping a percentage of my net worth in individual stocks. The percentage will probably be in the single digits but it will allow me to still sniff out companies which I think have great products and would like to invest in (most likely speculative/growth stocks). If they go belly up, I still will have 95% or more of my net worth in other investments. Take care.

      Reply
  4. B

    Hi FF

    The savings waterfall diagram is great!!!

    It serves sort of a checklist to ensure we are all doing fine in all aspects of financial planning. The social security system is a bit different here in asia (and in every country) but the idea is about the same.. maximizing full contribution to earn higher risk free rate interest.

    Reply
    1. Fervent Finance Post author

      It definitely is a good checklist. Sounds like our countries’ retirement systems are different. In most cases our employers pay into the SS system. The retirement accounts we fund individually are different and we don’t earn a risk free return on those. Thanks for stopping by.

      Reply
  5. Steve Adcock

    I’ll be honest – I don’t “Reddit” too often (awkwardly using the name “Reddit” as a verb). I have certainly been through the site, but I am the kind of person where if I get hooked, I spend WAY too much time on it. I remember years ago I was a member of a very busy Corvette forum back when I drove around in a Vette, and yeah, I spent hours on that thing. I don’t want Reddit to turn into that for me. I spend way too much time on the computer as it is! 🙂

    But, the Savings Waterfall is an excellent way to map out your finances and prepare a good foundation for yourself. My wife and I pretty much have everything covered except for the emergency fund. We do have one, certainly, but it’s only at about 60 or 70% of what we’d ideally like it to be, so we’re working to remedy that every month.

    Excellent little graphic. Kudos to BrainSturgeon.
    Steve Adcock recently posted…Life is short, so live a little…they sayMy Profile

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    1. Fervent Finance Post author

      I’ve since taken a break since my initial day one binge. I don’t think a 6 month EF is as important for you guys as you could live off either spouse’s salary if one could not work. But if you’d feel more comfortable with it higher, than all the more power to you to get it there.

      Reply
  6. Abigail @ipickuppennies

    I only recently heard about the waterfall, but it seems pretty sound. I skip three steps. I don’t have a 401(k) so no contribution match, nor is it an option after my Roth. And I’m currently not able to max my Roth in and around our various expenses. (We’re saving for a $25,000 oral surgery bill next year.)

    I want to make next year the Year of Retirement Funding. I want to open and max out a SEP IRA. Then, once we’re comfortable doing that, I want to open a Roth for my husband and max that out. Which will probably take until at least 2017, but at least we have a plan.
    Abigail @ipickuppennies recently posted…Change of plansMy Profile

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    1. Fervent Finance Post author

      Hi Abigail. I agree – as long as you have a plan, the rest will hopefully fall in place. Good luck with everything!

      Reply
  7. DC @ Young Adult Money

    I’ve never used reddit, more so out of lack of time than anything. I like the waterfall though I disagree that debt should always be prioritized over investing. For example I have an interest rate of a little over 3% on my mortgage. It’s a fixed rate and won’t change for 30 years. The odds of interest rates being a lot higher than that in the future are pretty good. It would be foolish, in my opinion, to pay that off before investing.
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    1. Fervent Finance Post author

      I agree DC. It says pay high interest debt first, so I interpreted that as pay off high interest rate debt first then move on in the waterfall, but I guess you’re right and it’s pointing to paying off all debt. I do the same with my student loans at 3%. I totally agree with your strategy. My cut off mentally is 4% and higher, and I’d pay that off before after-tax investments.

      Reply
  8. Even Steven

    I always find the savings waterfall interesting, partially because I repeatedly ask myself this question over and over, arguing with myself for long periods of time in my head:)

    I go back and forth on the Company 401K trumping the IRA portion, I also wonder if this works for FI, especially if you make the national average of around 50K. If this is the case you would be living on an estimated 25K each year for expenses, which is a pretty small amount and then doesn’t include any contributions towards individual investments or an H.S.A., which will be needed for FI during the 5 years that you are converting money.

    I like the Savings Waterfall though, good guideline, thanks for sharing your thoughts.
    Even Steven recently posted…Keeping Up With the Mustaches Forget the JonesesMy Profile

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    1. Fervent Finance Post author

      Since my 401k options through work are so great, I went 401k first then IRA just for simplicity (only $40 flat admin fee a year in 401k). But for others with fee ridden 401k’s it definitely makes sense to go IRA route to save on fees. I agree on you that this isn’t for everyone. Depending on COL, this is probably great for people making $60k-ish or more a year, but the ideas are applicable to everyone.

      Reply
    1. Fervent Finance Post author

      Agreed – I think it makes a great visual piece for someone questioning what they should do with their money.

      Reply
  9. Mrs. Frugalwoods

    That waterfall process makes sense to me! And, way to go on low-fee index funds–that’s definitely what we do. Another great source for community feedback on personal finance are the Mr. Money Mustache forums. They’re geared towards early retirement strategies, but I find the threads really helpful and filled with interesting people and ideas. Just wanted to pass that along in case you’re looking for another online community. And, thanks for the shout-out :)!
    Mrs. Frugalwoods recently posted…The Surprising Benefits Of Not Turning On Your Air ConditioningMy Profile

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    1. Fervent Finance Post author

      Thanks Mrs. Frugalwoods. I’ll have to check out the MMM forums. Have a nice weekend 🙂

      Reply
    1. Fervent Finance Post author

      Thanks SB. I haven’t began the process of trying to monetize the blog yet, but it could be in the future.

      Reply
    1. Fervent Finance Post author

      I like reddit for the reason that complete strangers will give thought out advice to help others. After a while a lot of the stories and advice becomes repetitive. But definitely great for some different ideas and another point of view.

      Reply
  10. Holly@ClubThrifty

    I like the savings waterfall idea! Good job maxing out your 401K. I don’t blame you for waiting on your student loans at 3%. I could probably live with that too at this point in my life.

    Reply
    1. Fervent Finance Post author

      I’m pretty debt adverse, but at 3% I think I’m going to at least milk those for a few more years. Take care!

      Reply
  11. Justin @ Root of Good

    Thanks for the shout out and congratulations on finding reddit. 🙂

    As for your Bogleheads conversion, welcome to the faith bro! I stuck with many of my individual stocks and eventually closed out most of those positions. Although I’ll still make a gamble every year or two (not that I’ve done that well…).
    Justin @ Root of Good recently posted…The Early Retiree’s Weekly ScheduleMy Profile

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    1. Fervent Finance Post author

      My pleasure Justin. I am doing the same and closing out the positions that won’t have a significant tax impact. But I still like evaluating companies and will dedicate a small portion of my nest egg to individual growth stocks but it will be very small. Take care!

      Reply
    1. Fervent Finance Post author

      Thanks Adam, appreciate it. Summer definitely gets away from me on the spending front with travel and weddings, but I usually rain it in pretty nicely once fall and winter roll around.

      Reply
  12. Chella

    The manner by which the waterfall has been used to create a vivid expression of how one should save and invest their money has given me a deeper insight and a better understanding on how I should handle my finances. I will definitely check out reddit and gain as much as it has to offer.
    Chella recently posted…Millennials Are Unprepared For RetirementMy Profile

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