3 Steps to Start Building Wealth

Getting control of your finances starts with building a strong foundation.

In the first part of this series, we talked about saving one month of expenses, beginning to invest for your future, and attacking high-interest debt.

Once those pieces are in place, we can start shifting our focus.

Instead of simply trying to get our heads above water financially, we can start intentionally building wealth.

But before we go all-in on investing, there's one more piece of protection I want in place.

Here are the next three steps I recommend.

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Step 4: Build a Full Emergency Fund

Earlier in the process, our goal was to save one month of expenses. That gave us an initial buffer between ourselves and the unexpected.

Now it's time to finish the job.

I generally recommend building an emergency fund equal to three to six months of expenses.

I like to think of your emergency fund as a moat around everything you're building financially.

Before we build the castle too high, we want some defenses around it.

Life is going to happen. Jobs change. Cars break down. Appliances quit working. Medical expenses come up. None of us knows exactly what the next emergency will be—we just know that eventually there will be one.

Your emergency fund helps prevent those events from undoing the financial progress you've already made.

Do You Need Three Months or Six Months?

There's no single number that's right for everyone.

When deciding how much you should keep in your emergency fund, I generally look at three things:

1. How reliable is your income?

If you have a stable paycheck, work in an industry with consistent demand, and believe you could find comparable work relatively quickly if something happened to your job, you may be comfortable closer to three months.

If your income is seasonal, commission-based, highly variable, or tied to an uncertain industry, having closer to six months may make more sense.

2. How many people depend on your income?

Someone supporting only themselves may have a different need for cash reserves than someone supporting a spouse and several children.

Generally, the more people depending on your income, the more protection I like to have.

3. What helps you sleep at night?

I sometimes call this the pillow test.

Some people are naturally comfortable with financial risk. They don't get overly concerned when markets move, and they'd rather keep less cash on the sidelines so more of their money can be invested.

Others feel much more comfortable knowing they have six months of expenses sitting safely in savings.

That matters.

If having additional cash prevents you from panicking during a market downturn or making drastic financial decisions when something unexpected happens, that extra cushion can serve an important purpose.

Your emergency fund isn't only about optimizing a spreadsheet. It's also about creating enough financial security that you can stick with the rest of your plan.

Your Emergency Fund Is Meant to Be Used

Not long ago, our hot water heater went out.

By the time we purchased the replacement and had a plumber install it, we were out roughly $3,000–$4,000.

Was that how I wanted to spend several thousand dollars?

Absolutely not.

But financially, it wasn't a crisis.

We had an emergency fund.

Instead of putting the expense on a credit card or selling investments to come up with the money, we could simply pay for it.

Then we rebuilt the emergency fund and continued with our financial plan.

That's exactly what this money is there to do.

And it illustrates something important about these financial steps:

They're not always linear.

You might build your emergency fund, move on to investing, and then have an emergency six months later that uses a portion of your savings.

That's okay.

Go back, refill the emergency fund, and then continue moving forward.

The goal isn't to build it once and never touch it. The goal is to maintain that layer of protection around your financial life.

Step 5: Prioritize Tax-Advantaged Accounts

Once our emergency fund is fully established, we can really start focusing on wealth creation.

One of the first places I like to look is at the tax-advantaged accounts available to you.

Two accounts that can be especially valuable are a Roth IRA and, for those who qualify, a Health Savings Account (HSA).

Why I Like Roth IRAs

An IRA is an Individual Retirement Account, and there are two common types: Traditional and Roth.

The primary difference is when you receive the tax benefit.

With a Traditional IRA, eligible contributions may provide a tax benefit today. The money can then grow tax-deferred, and distributions are generally taxable when withdrawn in retirement.

A Roth IRA works differently.

You contribute money you've already paid taxes on. The money can then grow within the account, and qualified withdrawals in retirement can be tax-free.

That can be incredibly valuable.

If you're investing for decades, a significant portion of your ending account value could eventually come from investment growth rather than the dollars you originally contributed.

A Roth IRA potentially allows that qualified growth to come out tax-free in retirement.

That's why, for someone who is eligible and for whom a Roth makes sense, I like making it a priority.

Contribution and eligibility rules can change over time, so make sure you're using the current IRS limits and rules when deciding how much you can contribute.

Don't Overlook the HSA

The other account I really like is the Health Savings Account, or HSA.

Not everyone is eligible for one. Generally, you need to be covered by an HSA-eligible high-deductible health plan and meet the applicable eligibility requirements.

But if you qualify, an HSA can be an extremely powerful financial planning tool.

HSAs can offer three potential federal tax advantages:

• Contributions may be made on a pre-tax or tax-deductible basis
• Money can grow tax-deferred within the account
• Withdrawals for qualified medical expenses can be tax-free

That's a unique combination.

Many people think of an HSA simply as an account they use to pay this year's medical bills.

There can be another strategy.

If your financial situation allows you to pay current medical expenses from other funds, you may be able to leave HSA assets invested for future qualified medical expenses.

That gives the money more time to potentially grow while preserving the account's tax advantages.

There are important eligibility, contribution, distribution, and recordkeeping rules surrounding HSAs, so this is an area where the details matter.

But the bigger principle for this step is simple:

Once you've built your financial defenses, start taking full advantage of the tax-efficient opportunities available to you.

Step 6: Work Toward Investing 25% of Your Income

Now we're going to get more aggressive about building wealth.

My stretch goal is to work toward investing 25% of your income for the future.

For many people, that number probably sounds high.

It is.

And you're not necessarily going to get there overnight.

But there's a reason I like setting the goal high.

One of the most important principles in building wealth is learning to live on less than you make and consistently invest the difference.

The bigger the gap you can create between what you earn and what you spend, the more money you can put to work toward your future.

Why Aim for 25%?

A lot of people don't seriously begin investing for retirement in their early 20s.

Maybe you didn't learn about investing until your 30s or 40s. Maybe you spent the first part of your career raising kids, paying off debt, building a business, or simply trying to make ends meet.

You can't go back and change when you started.

But you can change what you do from here.

That's one reason I like 25% as a stretch goal.

Maybe you're currently investing 8% and can't immediately jump to 25%.

That's okay.

Maybe you get to 15%.

Then 18%.

Then 20%.

And perhaps eventually you reach 25%.

If aiming for 25% causes you to consistently invest substantially more than you otherwise would have, the goal has done its job.

This isn't about feeling like you've failed because you didn't hit an arbitrary percentage.

It's about continually increasing the amount of your income that's working toward your future.

Where Should You Invest That 25%?

This doesn't necessarily mean putting 25% of your income into one account.

Instead, think about all of your investment accounts working together.

A general order I like to consider is:

1. Contribute enough to your workplace retirement plan to receive the full employer match
2. Fund a Roth IRA if you're eligible and it makes sense for your situation
3. Fund an HSA if you're eligible
4. Consider additional workplace retirement contributions or a taxable brokerage account

Your personal circumstances may change that order, but the goal is to intentionally decide where each additional investment dollar should go.

401(k) or Brokerage Account?

Once you've taken advantage of the accounts we've already discussed, you may still have additional money available to invest.

At that point, you might increase your contributions to your 401(k) or other workplace retirement account.

Another option is a taxable brokerage account.

I like brokerage accounts because they can provide additional flexibility.

Retirement accounts offer valuable tax advantages, but they're designed primarily for retirement and generally come with rules around accessing the money.

A taxable brokerage account doesn't provide all of those same tax advantages, but it can give you more flexibility in how and when you access your investments.

That can be particularly useful for someone interested in retiring before traditional retirement age.

For example, someone who wants to retire early may eventually use assets in a brokerage account as a bridge between the date they stop working and the date they begin accessing other retirement assets.

That doesn't mean everyone needs a brokerage account.

If your employer match, Roth IRA, HSA, and other retirement contributions already get you to your savings goal, that's great.

The point is to build an investment strategy around your goals, rather than simply putting money into accounts without understanding what role each one plays.

From Financial Stability to Wealth Building

Once you've completed these three steps, your financial picture starts looking very different.

You have a full emergency fund protecting you from the unexpected.

You're taking advantage of tax-advantaged accounts that can help you build wealth efficiently.

And you're directing a meaningful percentage of your income toward investments for the future.

You've created both defense and offense in your financial plan.

The emergency fund is the defense. It helps protect everything you've already built.

Your investments are the offense. They're the part of your plan designed to move you toward greater wealth and, ultimately, financial independence.

That's the transition we're trying to make.

We're no longer simply trying to avoid financial emergencies or get out of debt.

We're intentionally building a financial future.

These are Steps 4, 5, and 6 of our eight-step framework for taking control of your money.

In the final part of this series, we'll cover the last two steps and bring the entire plan together.

This material is provided for educational purposes only and is not intended as individualized investment, tax, or legal advice. Eligibility for and taxation of retirement accounts, HSAs, and other investment accounts depend on individual circumstances and applicable rules. Investing involves risk, including the possible loss of principal. Consult the appropriate financial, tax, or legal professionals regarding your specific circumstances.