So you have a few dollars to save, pay off debt, or invest for the future. What do you do with the money so that you can achieve your goals as quickly and easily as possible, and not waste time and money on poor decisions?
Step One: Your Emergency Fund
He has received an inheritance of $50,000. What do you do with the money? Yes, you could buy that big screen TV and sound system and take an unforgettable vacation, but what if you wanted to make big strides toward your goals and not let the money go to waste?
You have $500 left over after paying your monthly bills and other fixed expenses, and you set aside money for gas, groceries, clothing, and other necessary expenses. You could spend this money on small luxuries, pay more on your mortgage, or save for retirement. How do you make the decision?
The first priority should be setting aside money in your Emergency Fund. Yes, even before you pay off your credit card debt (unless you’re delinquent or delinquent on your bills, then pay enough to bring them current first).
Regardless of how much credit card debt you have, the first step to creating a prosperous future is to change your habits. When the unexpected bill comes (and it always does), you should have money in your Emergency Fund to pay that bill, to avoid racking up additional credit card debt. If you’ve spent every extra dollar trying to pay off your debt and have no money saved, when something unexpected happens, you’ll rack up even more debt and be right back where you started.
Your Emergency Fund should contain three to six months of your actual basic living expenses. Or more… I have some clients with up to a year of cash set aside; They are typically risk-averse, self-employed, or have a fluctuating income stream. Your amount is not three to six months of your salary, it is the bills and necessarily the expenses that you would have if you could not earn income. These funds must be kept in a cash account, usually a savings or money market account. The Weinstein family’s emergency fund is in an ING Direct Orange savings account.
A home equity line of credit (HELOC) does not count. Yes, you can use a home equity line of credit or take out a home loan if you can’t earn income or have emergency expenses. But, it would only further increase your monthly expenses and your debt. And, since interest rates have risen, even the tax deduction isn’t worth the high expense of using the HELOC.
Once you have a well-established habit of saving money each month and have set aside your Emergency Fund, we can move on to the next step: prioritizing debt and your life goals.
Action step one:
Open a dedicated emergency savings or money market fund account. Set aside a set amount of money each month, either $50, $500 or $5,000, until your fund reaches three to six months of your living expenses.
Step Two: Pay off the “bad” debt
You’ve established your Emergency Fund and created a wonderful habit of saving $50, $500 or $5,000 each month. We don’t want to let that habit die… so where do we put your money now?
Step 2 is to pay off any “bad” debt. What that means really depends on the person and their tolerance for debt. Some people aren’t particularly bothered by debt, so their only “bad” debts are those with high interest rates or minimal tax advantages (debts that aren’t mortgages or student loans).
There are two situations where I can ignore the interest rate and advise the client to pay off the debt as soon as possible.
(1) Loans from relatives or friends. These loans, although low interest, may be killing the relationship, without you knowing it. They can reduce the relationship to a formal, tense, money-based transaction, rather than a loving, friendly, and supportive bond. You may know that debt is an issue, or ask other relatives to see if debt is an issue in the family’s culture; if so, please pay promptly.
(2) Debt that keeps you up at night or makes you feel unsuccessful. Debt may be the new “American way,” but it’s not right for everyone, or even most people. Monthly payments, or even the thought that you could be garnished or repossessed, may be eating at you overnight. You may feel venerable, or like you never achieved any of your goals until you paid off that debt.
If this is the case for you, then your debt may become a high priority, even above other goals like financing college or buying a new home. Whether your debt should be paid off as a high priority depends not only on the interest rate, but also on the mental and emotional interest rate you’re saddled with each month you make loan payments.
Action step two:
Take a personal inventory of your debts and how much they are costing you in mental and emotional energy. They bother you? How much? If so, regardless of how low the interest rate is, paying them off should be a high priority. Get Started Today – Pay an additional $10, $100, or $1,000 on principal each month. Even better, set up automatic bill payments in your online bank account’s bill payment system to make additional regular automatic payments each month or quarter.
Step Three: Goal Financing: Entry Level
Now you’ve established your Emergency Fund and paid off your “bad” debt, including a loan from a family member, a high-rate credit card, and old college debt that was really bugging you.
He has a ton of goals: retire, pay off his mortgage, buy his next home, launch a new business, and send the kids to college.
Which comes first? Withdrawal? The children? Pay your debts? How do you decide?
Step 3 of Where to Put Your Next $1 is to fund your goals, in order of priority, at the basic levels: the amount of money you need to meet the minimum requirement of your goal.
For example, how much money do you need to pay your bills when you retire, not to live an extravagant lifestyle, play golf every day for 20 years, or travel the world, but how much money to keep out of a cardboard box? and live comfortably?
How much money do you need to save to send the kids to State College, as opposed to the Ivy League? How much would the house you need cost, compared to the house you want?
Then fund the minimum base level of those goals in order of priority. This may mean you start by contributing to your retirement plan or IRA, then contribute to a 529 Plan for the kids’ college education, then set aside money in a CD to start a business in 3 years, and then finally invest to raise funds . for a bigger house.
How is the order of priority decided? First, determine if there is another way to pay for the goal besides your own savings; if so, then it’s probably a lower priority than goals for which you have no alternative. For example, loans are readily available for college education, but not for retirement (with the exception of a reverse mortgage). Also, you can get investors or apply for a loan to finance a new business and pay them with the new income stream.
Second, consider whether you’re giving up “free money” by not using pre-tax retirement or savings plans or equivalents. If you can save before taxes, the federal government is contributing to your goal (since you don’t have to pay those taxes), and if you don’t take advantage of this each year, you’re leaving money on the table. . Likewise, if you’re lucky enough to be employed by a company that matches a 401(k) plan, you may want to contribute at least the match, to “allow” your employer to help fund your retirement.
Action step three:
Make a list of your goals, in order of priority. Look at your goal no. Issue #1: Is it really the most important or is it just first in time order? Any special type of accounts or matches available for this goal? How much will your goal cost? What is the base level for that goal?
Set aside money each month to fund the base level of your #1 goal; use your automatic savings or investment plan to complete this week’s action step.
Step Four: Above and Beyond…
You maxed out your Emergency Fund, paid off your “bad” debts, and financed the minimum levels of your most important life goals. Great job! Whats Next?
Step 4 is to fully fund your goals, in order of priority. For example …
* Max out your Roth IRA, if eligible. * Max out your 401(k) and IRA (yes, you can do both, the IRA may not be deductible). * Buy ESPP shares (and don’t forget to sell and diversify regularly). * Contribute to a 529 Plan and/or taxable investment account for college education. * Invest in taxable or tax-advantaged accounts for miscellaneous future goals or additional retirement funds. * Purchase investment real estate and/or rental properties. * Pay off your mortgage. * Buy CDs or Bonds for specific purposes with expiration dates. * Leave the money in your health savings account, invested and tax-deferred, until you can roll it over to an IRA when you retire.
Wow, do you still have money on the table? Wonderful! If your goals are already funded, don’t forget to enjoy your money now. Take a first-class vacation, hire a traveling service for a few hours each week, buy a new sound system, or make a significant donation to your favorite charity. Balance saving for your future goals with living life now.
Action step four:
Choose your highest priority goal from Step 3. Have you fully funded this goal to achieve your ultimate dream? Evaluate whether you have funded the minimum level of your other goals. If so, choose an action step from the list above… and enjoy your prosperity!
