What is the most important thing to do to improve your financial situation? Is it paying down your debt, saving more money, sticking to a budget, or something else entirely? There are literally hundreds of things you can do in order to improve your finances, but some are much more important than others.
Here are the four most important things you have to do if you want to achieve financial health, with the most important ones listed first.
Have decent health insurance
Now, you may be surprised that I ranked health insurance as the most important step toward financial health. However, there is a very good reason.
If you don't have health insurance, or you have "so-so" coverage, you are literally leaving yourself vulnerable to financial ruin at any time. What if something catastrophic happens and you're stuck with $100,000 or more in medical bills? Or, if you have a "high-deductible" plan, would you really be able to afford to pay your deductible all at once if something were to happen?
Additionally, your health is the most important thing to a long and happy life. It doesn't matter how much money you have in the bank if you aren't healthy enough to enjoy it.
Thankfully, the Affordable Care Act has made strides towards making health insurance much more, well, affordable. And the difference between a "so-so" and a good insurance plan may be less than you think.
A quick search on Healthcare.gov shows that a "bronze" level plan with a $6,300 deductible will cost $199 per month for a 35-year-old nonsmoker in my state, and a "silver" plan with a $2,000 deductible and much lower co-pays will cost $270 per month. And bear in mind that these are the prices without any subsidy, which you might qualify for.
In my opinion, that difference of $71 per month is well worth the cost for the financial peace of mind it provides.
Build up an emergency fund
A recent Federal Reserve study found that about half of Americans would be unable to cover a $400 unexpected expense without using a credit card, borrowing the money, or selling something.
If you don't have a sufficient emergency fund set aside, that should be your top priority after you've taken care of your health care needs.
Many experts (myself included) recommend that you try to build up an easily accessible emergency fund with enough money to cover six months of your expenses, but if you can get three months' worth it would be a very good start. And you might be surprised just how much this is. Remember to include all of your housing expenses, as well as your recurring bills, your car, groceries and more. Here is a more thorough discussion of how you can determine the proper size of an emergency fund for you.
Pay off high-interest debt
Before you can invest properly, you have to get your high-interest debt under control, which means paying off your credit cards.
And here's why. Even the best investors are unlikely to produce better than 12% annual returns on their investments on a consistent basis. According to Bankrate, the average interest rate on a variable-rate credit card is currently about 15.7%, and many cards have much higher rates.
Let's say that you put $5,000 in an investment account and also carry a $5,000 credit card balance. Well, if you earn 12% investment returns (very optimistic), your account will earn $600 in profit for the year. However, by maintaining a $5,000 credit card balance, you'll pay nearly $800 in interest, assuming you have the average rate.
So, by carrying credit card debt, you would actually lose $200 for the year, even though your investments performed very well. That's why it is so important to get your credit cards under control before you direct your money towards investing.
One these other three steps are done, then and only then does it make sense to start putting your money into an investment account.
Now, don't get me wrong -- I certainly don't want to understate the importance of investing your money. As I have written many times, there is not a more certain path to wealth than a smart investment plan.
The point here is that in order to be an effective investor, you don't want to have any of these things hanging over your head. Without health insurance, a hospital stay could easily wipe out the portfolio you've worked so hard to build. Without an emergency fund, losing your job could force you to sell all of your investments just to pay the bills. And, with credit card debt, earning strong returns on your investments can be a futile effort.
To truly be financially healthy, you don't want anything to be able to destroy your investment returns. If you take care of these other things, your investment portfolio will be free to do what you want it to do: grow.