YouTubers often pitch investing tips, but few break down how to grow your money while keeping taxes to a minimum.
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In a video by financial creator John Liang, he outlined a practical, tax-efficient strategy for investing your paycheck in the right order, starting with protection and ending with growth.
Build an Emergency Fund
While not flashy, your first priority needs to be saving money in an emergency fund. While Liang acknowledged that this is a savings account, not an investment account, having this in place can help your long-term investment strategy, as you can use this money in case of emergency rather than pulling money out of other investments.
Liang recommended having one month’s worth of expenses in a high-yield savings account as soon as possible. He advised building up the emergency fund from there while also funding other accounts.
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Max Out Your Employer Match
Liang called this “the only investment in which you’re going to get a 100% return on your money.”
If your employer matches 6% of your salary in a 401(k), contribute at least that much since it’s free money and offers tax-deferred growth.
While putting in enough money to get the employer match may not be possible in your financial situation, Fidelity advises budgeting and doing what you can to get as much of the employer match as possible, as that will help your finances over the long term.
Pay Off High-Interest Debt
Next, Liang recommended paying down debt with a high interest rate. “[Credit cards] could have interest rates going anywhere from 18% up to 28%,” Liang said. “That is doing you no favor. In fact, to me, that is like … a financial anchor that’s dragging you down.”
In fact, according to Equifax, carrying a lot of high-interest debt that’s not managed properly can lead to a lot of financial problems. For example, it can harm your credit score, which could make it harder to borrow money in the future if needed.
Liang suggested using either the debt avalanche (paying off the debt with the highest interest rate first) or snowball (paying off the debt with the smallest balance first) method. You can also consider 0% APR balance transfer cards, but only if you pay it off aggressively before the promotional period ends.
Fund a Health Savings Account
The money you put into an HSA is triple tax advantaged, per Liang. That means contributions aren’t taxed, the money in the account grows tax-free and you get tax-free withdrawals for qualified medical expenses.
According to the IRS, to qualify for an HSA, an individual must be covered by a high-deductible health plan, have no disqualifying coverage, not be enrolled in Medicare and not be eligible to be claimed as a dependent. Married couples must open separate HSAs, though funds can be used for each other’s qualified expenses.
Liang’s hack is to pay medical costs out of pocket and reimburse yourself years later, letting the money grow all the while.
Max Out Retirement Accounts
Liang recommended maximizing either a traditional 401(k)/IRA or a Roth IRA/401(k), depending on your tax situation. He explained that traditional options defer taxes, while Roth options offer tax-free growth.
“I actually do lean a little bit more towards a traditional 401(k) just because I can reduce my current year tax liability,” he said.
Pay Down Medium-Interest Debt
Liang classified debts such as auto loans and federal student loans as medium-interest, and he recommended paying them off next, depending on some factors.
For example, if the interest rate is higher than what you’d expect from market returns, paying down that debt may offer a better risk-adjusted payoff than investing, especially if you value guaranteed savings.
Invest In a Taxable Brokerage Account
Brokerage accounts are not tax-efficient, so Liang prioritizes them lower. When you do invest, he suggested sticking to low-cost broad-based index funds, like the Vanguard Total Stock Market Index Fund ETF (VTI), the Vanguard S&P 500 ETF (VOO) or the Vanguard Total International Stock Index Fund ETF (VXUS).
Also, Liang recommended avoiding flashy trading apps that encourage excessive activity, such as Robinhood. “The fastest way to lose money is to buy and sell, buy and sell, buy and sell. Pick the apps that have ‘unsexy’ UIs because, again, the secret to investing is: put the money in, watch it grow, don’t touch it, you’re wealthy,” Liang said.
Pay Off Low-Interest Debt
Mortgages with rates under 4% aren’t as urgent to pay down. Liang suggested investing extra funds instead to earn a higher return.
If peace of mind is your goal, paying early is fine. For a mortgage, a smart middle ground is to make biweekly payments to finish years sooner and save thousands in interest. In a recent article, money expert Rachel Cruze also offered that strategy to pay off a mortgage earlier, as well as refinancing, downsizing and making more room in your budget.
Ironically, Liang’s approach isn’t to just grow your money but to keep more of it. With this investment order strategy, you can invest smart while reducing your taxable income, letting your money work for you.
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This article originally appeared on GOBankingRates.com: The Best Way To Invest Money To Avoid Taxes, According to John Liang
