3 Mistakes People Make With Cash (And How to Fix Them)

Key Concepts

• Financial Order of Operations
• Emergency Fund
• Deductible Coverage
• Interest-Bearing Accounts
• Employer Match (401k)
• Employee Stock Purchase Plan (ESPP)
• Pre-tax vs. Roth 401k Contributions
• Marginal Tax Rate (Federal and State)
• Tax-Free Growth
• Current Year Tax Benefit

Financial Order of Operations and Year-End Planning

The video emphasizes the importance of year-end financial planning as a recalibration tool to ensure all necessary steps in the "financial order of operations" are being addressed. This planning can lead to significant benefits, including lower tax bills and accelerated retirement savings, ultimately benefiting one's future self.

Step 1 & 4: Cash Management

Cash is highlighted as a critical component, appearing in both step one and step four of the financial order of operations. The primary focus is on ensuring adequate cash reserves for emergencies and upcoming expenses.

• Deductible Coverage: A key question to answer is whether the highest insurance deductible (health, auto, home) is covered.
• Emergency Fund: The recommendation is to have 3 to 6 months of living expenses in liquid cash to prevent financial distress.
• Upcoming Expenses: Cash is essential for planned large purchases like car replacements or home system repairs, preventing desperate financial decisions.
• Interest-Bearing Accounts: It is crucial to ensure that cash, even if held for liquidity, is not sitting in low-yield accounts. The video suggests that cash can earn 3.5% to 4% interest in current market conditions, urging viewers not to let it "waste away."

Step 2: Maximizing Employer-Provided "Free Money"

Step two focuses on taking advantage of "free money" offered by employers, particularly through retirement plans and stock purchase programs.

• Employer Match: A significant portion of individuals (estimated at 25% or 1 in 4, according to Vanguard) are not contributing enough to receive their full employer match in their 401k. The video stresses the importance of understanding the employer's matching formula (e.g., "if you put in 6% we'll put in 3%") and contributing at least enough to capture this benefit.
• Counting Employer Match Towards Savings Goals: For individuals with an income under $200,000, the employer match counts towards the recommended 25% savings goal, making it a substantial contributor.
• Employee Stock Purchase Plans (ESPPs): If available, ESPPs are also considered "free money." This can manifest as discounts on stock purchases (e.g., 15% off) or programs that allow employees to buy stock at the lowest price within a given offering period.
• Risk Mitigation: While acknowledging the risk of having human capital and investment capital tied to a single employer, the video emphasizes the power of "free money." The strategy is to take advantage of these benefits initially and then develop a plan to manage the concentration, aiming for the ESPP portion to be no more than 5% to 10% of total net worth.

Pre-tax vs. Roth 401k Contributions

A critical decision for year-end planning involves choosing between pre-tax and Roth 401k contributions. This decision hinges on an individual's current and projected tax situation.

• Marginal Tax Rate: The key determinant is the combined marginal tax rate, which includes both federal and state income taxes on the next dollar earned.
• Roth Contribution Recommendation: If the combined marginal tax rate is under 25%, contributing to a Roth 401k is generally recommended due to the value of tax-free growth in a low tax bracket.
• Pre-tax Contribution Recommendation: If the combined marginal tax rate is above 30%, pre-tax contributions are often more beneficial due to the immediate tax deduction, which can be viewed as a significant "current year tax benefit" (potentially a 30% imputed rate of return).
• "Gray Zone" Decision-Making: For individuals in the 25% to 30% marginal tax rate range, the decision requires considering additional factors such as:
  • Current tax rate versus expected future tax rate.
  • Current account structure and how existing "buckets" of savings are allocated.

Accessing Tax Information

To assist viewers in determining their marginal tax rates, the video directs them to moneyguy.com/resources for their 2025 tax guide. This resource can help identify federal marginal tax rates based on income, providing a head start in making informed contribution decisions.

Conclusion

The video advocates for proactive year-end financial planning by leveraging the financial order of operations. Key takeaways include ensuring adequate cash reserves, maximizing employer-provided benefits like 401k matches and ESPPs, and making informed decisions about pre-tax versus Roth 401k contributions based on marginal tax rates. These actions can lead to immediate tax savings and long-term wealth accumulation.