I’ve read some articles on this recently and most of them miss the most important points.

The situation: typical middle class worker who is making ends meet, but maybe not by much. You unexpectedly get $1000. What’s the best way to use this money? Let’s assume you don’t have to pay income tax on it – if you did, set aside 20% to 25% of it now.

Number 1 is to pay off credit card and similar debt. If you don’t have any, congratulations, move on to Number 2. This has high interest rates and is not tax deductible. Every dollar you put toward that pays for itself in spades. And most importantly, after paying off that debt, don’t take out more! The first step to get yourself out of a hole of debt is to stop digging. That means work out a budget within your means and stick to it, stop spending more than you earn.

Number 2 is to pay off other kinds of debt. For example, car loans. If you can’t pay it off in full, send extra money to reduce the amount of debt. However, don’t pay off a mortgage early if the interest rate is less than 5% (especially if tax deductible). Every dollar you put toward paying off a mortgage early gives you better returns if you invest it.

Finally, if you have no debt other than mortgage, invest whatever is left over. For retirement investing, put more money into your 401K or IRA. If it’s already maxed out, you can put after-tax dollars into a Roth IRA. Even if you make too much money to quality for Roth, you can still do it through the “Roth backdoor”. That is, put after-tax dollars into a traditional IRA, then immediately roll them over into a Roth IRA. For long term investments (more than 5 years), equities and equity funds are the way to go. For 1-5 years, reduce volatility with a blend of stocks and fixed income. For < 1 year, fixed income like a CD is best.