First Things First: Build an Emergency Fund
Experts agree you should have three to six months of living expenses set aside in a safe, interest-bearing account. What you earn on that money is irrelevant. The main goal or objective of this investment is liquidity. Not having an emergency fund can prove to be a very costly mistake. For example, if you need to replace the brakes in your car, if your rent increases, or if you even lose your job. None of this is predictable. Without an emergency fund most people reach for the high-interest rate credit cards to pay their expenses. This strategy is in conflict with your long-term goal of saving for retirement.
One consideration: A Roth IRA. The Roth is unique, in that any contributions you make to a Roth can be withdrawn without penalty or taxes. The caveat is that any earnings in the account need to remain for five years and you must be 59.5 years old or older (unless an exception applies) for it to be considered a qualified distribution to avoid taxes and a 10% penalty. In turn, you are technically saving for retirement and building a nest egg for any short-term unexpected expenses (i.e., emergency fund). Check out our Roth in Retirement Plans webinar to learn more.
Next: Prioritize Your Debt Load
Maybe you have a car payment, student loans and miscellaneous credit cards. Put together a budget that reflects balances, monthly payments, as well as the interest rate attached to each of the debts. Once you have a clear understanding of your debt load you can then develop a plan to paydown the debts. There are a couple different schools of thought on this. You can either begin by making a “monster” payment on the credit card with the highest interest rate after the minimum payments are made on other debts with lower interest rates. This is referred to as the “avalanche” method and ultimately saves you the most in interest payments.
Secondly, there is the “snowball” method. Here you make the “monster” payment on the account with the lowest account balance. How do you eat an elephant? One bite at a time. The same is true for your debt – break down the debt into bite-sized pieces to make it more attainable and less scary.
There is no right or wrong method because everyone has a unique approach to managing their finances. If you are someone who can sleep better knowing you have completely paid off a debt and no longer owe money to a given creditor then the “snowball” method probably makes sense. Whereas, if you are a numbers-driven person and feel saving more money on interest charges over the long-term makes more sense the “avalanche” method might be for you.
Watch our “Connecting the Dots to Your Financial Future (Part 1)” webinar for learning more about these strategies to pay off your debt.
Wait: My Company Matches My Retirement Plan Contributions
If you are fortunate to work for an employer who matches your retirement plan contributions, then that is free money you should grab. For example, if your company will put in 50 cents for every $1 you contribute that is a 50% return in your account immediately! This strategy should be prioritized over paying down anything above and beyond the minimum payments owed on any debts described above.
The Bottom Line
It really comes down to personal preference. The math would suggest that you should maximize retirement savings while taking advantage of the current low-interest rate environment and potentially refinance debt if possible. However, if you’re someone who sleeps better knowing you don’t owe money to others that works just as well.
A Certified Financial Planner™ at BFSG can work with you to develop a plan designed to help you save for retirement and pay-off debt to achieve your financial goals.
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