I am currently on my way home from visiting my in-laws in Minnesota, so please enjoy this post from Kali Hawlk. Kali blogs about personal finance over at CommonSenseMillennial.com.
Fundamentally, personal finance is pretty simple. Spend less than you earn and try to save more than you spend. Easy, right?
But of course, it always seems to be more complicated than that with retirement to think about, debt to deal with, bills to pay, and goals to reach. Not many of us have just one financial priority to think about; instead, we’re forced to try and make our income stretch as far as possible to take care of multiple things.
To keep all the balls in the air, we have to learn to balance. It will be hard to be successful with our personal finances if we blindly focus on one goal at a time.
Here’s what to focus on in order of importance — and how to balance financial priorities with one another so you can work toward achieving all your big money goals:
Repaying debt is a tricky financial priority. On the one hand, if you throw everything you have at destroying your debt, you’ll get rid of it as fast as you possibly can. And you’ll save money on interest charges if you can pay off your debts quickly.
But you’ll also be “racing to zero” if you try this approach. This means that once your debt is repaid, you won’t have anything in savings or investments because all your spare cash went to credit card or student loan balances.
Remember, this is all about balance. Because of the negative financial implications of carrying debt, do put the majority of your available cash towards debt repayment each month.
But also hold back ten to twenty percent of this available cash and divvy it up between two other extremely important financial priorities.
First thing’s first: you need an emergency fund so you can handle unexpected expenses without having to whip out the credit card and push yourself even farther into debt. Without one, you’ll end up putting emergencies on a credit card or turning to short-term lenders such as Wonga.com.
It’s okay if you only have a little bit of money to contribute to your emergency fund each month. That little bit will add up, even as your debts are going down thanks to your other efforts. Aim for at least three months’ worth of you-have-to-pay-’em-no-matter-what expenses (like rent, utilities, and groceries). If you’re self-employed, you probably want to boost that number to at least six months’ worth of expenses (and aim for a full year).
If you don’t have debt, getting your emergency fund in place is going to be your top priority. But it still needs to be balanced with…
Whether you have debt or not, or have an emergency fund or not, your contributions to your first important financial priorities must make at least a tiny bit of room for what you need to save for retirement.
The easiest way to balance paying off debt and building an emergency fund with saving for retirement is to take advantage of free and tax-advantaged contributions where you can. This means signing up with your employer’s retirement account plan and opening something like a 401(k) (the specific account may differ depending on your line of work).
These retirement accounts are tax-deferred, which means you won’t pay taxes on the money you contribute now (you pay the tax when you withdraw the cash in retirement). This is good if you’re feeling cash-strapped. A bigger savings on your tax bill may mean more money in your pocket right now.
You need to contribute at least enough in your 401(k) or similar account to secure an employer match if you’re offered one. This may be anywhere from 1% to 6%. Get that match — it’s like free money! — and slowly up your contributions over time as your debt gets repaid and your emergency fund fills up.
If you’re self-employed, you can look into either a Solo 401(k) or SEP IRA. You won’t get the match, but your contributions are still tax-deferred.
Big Purchases in the Future
Once you’ve gotten your debt under control, established an emergency fund, and set up automatic monthly contributions to your retirement account, it’s time to focus on other big financial goals you set for your future.
Think things like a down payment for a home, funds for an around-the-world trip, or going back to school for some sort of additional certification or advanced degrees.
It will be much easier to balance these financial priorities with things like retirement contributions once all your debt is repaid and your emergency cash account is fully funded. These are important areas to invest in, but the reality is they’re fairly optional — or at least, much lower on the financial priority list.
Take care of your debt, establish your emergency fund, and get in the habit of regular retirement account contributions before allocating a small percentage of your monthly discretionary income to savings funds for big purchases in the future.
Yup, saving up for your kid’s college education came in last on this list for a reason.
As a parent, you want to give your children everything they need and then some. But you can’t provide a smooth ride for your kids if you don’t take care of yourself financially, first.
Not to mention, there are plenty of scholarships, grants, and options for paying for college (without racking up a ton of debt). Meanwhile, no one is going to write you a check so you can pay off your mortgage or add to your retirement fund.
It is okay to plan on helping your kids through their higher education years, but don’t feel obligated to give them a full-ride scholarship from the Bank of Mom and Dad. As they get older and approach their high school careers, you can start explaining to them that they will be expected to help out with college expenses.
They can do so by earning good grades and securing academic merit scholarships, dedicating themselves to a sport or other activity for which universities grant scholarships, or by picking up a part-time job to help pay for some discretionary expenses (like hanging out with friends). They also need to understand that different universities charge different tuitions. Help them understand all the different factors that go into college costs and what to think about when choosing a college.
How do you balance your financial priorities?