Step 3: Pay Down High and Moderate-Interest Debts

You’ll notice that, the further down the flowchart you get, the more open it becomes to interpretation; psychological and personal factors come increasingly into play.

This is the first place where my interpretation is decidedly different than the flowchart: while this flowchart defines “high and moderate-interest debts” as “debts with a 10% interest rate or higher”, I define it as “debts with a 5% interest rate or higher”.  I hate debt.  I want as little of it as possible.  I value the psychological effects of paying down debt very highly, so I make that a priority in my financial strategy.

If you’re like me and hate having debt, you may want to pay down some lower-interest debt; if you’re comfortable running a small balance, this may not bother you as much.  Either way is fine.  The decision is based purely on your psychological and financial state.

Step 3.5: Increase Emergency Fund to 3-6 Months’ Worth of Living Expenses

This comes between steps 3 and 4.  It’s not a bad idea, but I have a few optional modifications.

Instead of waiting to invest in IRAs (explained in Step 4) until you finish saving, you could put less money in the Emergency Fund each month and start investing now.  As an aggressive investor, this is what I do; I can’t wait to get that money working for me!  It will take longer to build up the Emergency Fund, but I’ll take that risk.

Another potential modification: this says to keep your Emergency Fund in a checking or savings account.  Depending on your situation, you may want to consider moving it to a money market account, or MMA, instead.  MMAs tend to have significantly higher interest rates than checking or savings accounts, but your access to the money is further limited (for example, you may only be able to write 6 checks per month out of a money market account).

MMAs are low-risk, FDIC-insured, and earn you more interest than a savings account would (NOTE: Money market funds, or MMFs, are not FDIC-insured, so be careful!).  Ask your bank if they offer money market accounts if you’re interested.

Step 4: Savings for Retirement in IRA and Higher Education Expenses