Day 16: Get your financial priorities straight. Is your money going where it should be? This post is part of FORBES’ 30 Day Money Challenge. Follow along on Twitter with #30DaysOfMoney or with the timeline posted here.
With more than half of U.S. taxpayers expected to receive a tax refund this year and the average refund clocking in at $3,120, it’s safe to say that a sizable number or people have a bit of a windfall coming their way soon (if not already). And if you are part of this group – or if you’ve recently benefited from a different type of cash infusion, like a raise or even a drastic cut in spending – you might be wondering: what should I do with this extra money?
Admittedly, not knowing what to do with extra money is the very
definition of a first-world problem. Extra money or not, though, knowing
how to prioritize your financial goals is important. Financial advisers
have told me that one of the most common questions they hear from
clients is, “should I put more money towards saving or towards paying
down debt?” Beyond paying off debt and beefing up your savings, you
might also be looking towards buying a home, starting a family,
launching a business and building up a vacation fund for your friends’
many, many weddings. If that’s the case, you might be wondering: where
should I start? Am I directing my money to the right thing?
The short answer to these questions is, before all else, save. Every financial planner interviewed for this article said that if you aren’t sure where to put your money, start by making sure you have basic emergency savings in place. As one planner once told me, “Paying down student loans isn’t going to help you when that emergency comes up.”
Beyond basic savings, the precise order-of-operations gets a little fuzzy. Personal finance is more art than science, and how you structure that art depends on you – your life, your goals, your priorities. However, there are some questions you can ask yourself to make sure your money is generally flowing in the right direction. Here’s what you should consider:
Do you have a ‘Stage 1’ emergency fund? Fee-only financial planner Matt Becker (who has a handy money priorities roadmap on his website, here)
has found it helpful to break savings goals into smaller pieces for
clients. “A big emergency fund is a great long term goal, and I’d
encourage people to work towards that. But it is intimidating,” Becker
says. “Most people aren’t going to be able to build a three month fund
right away. A one-to-two thousand dollar fund allows you to have some
kind of buffer against both good things and bad things.”
According to Becker’s hierarchy, focusing on building a bigger emergency fund (one with six or more months’ worth of expenses) should only come after you’ve purchased necessary insurance (more on that in a second), contributed to your 401k up to your employer match and paid off high-interest debt.
Are you missing free money at work? In other words: does your employer offer a 401k match, and are you getting it? If the answers to those questions are “yes,” and then “no,” you’re missing out on free money. See how much your employer matches (for instance, full match up to 3% of salary) and contribute enough to your 401k that you can nab the full match.
Is your debt load (a.) high interest or (b.) causing you to lose sleep? If you answered yes to either question and your savings are in decent shape, consider kicking any spare cash flow to paying more than the monthly minimum payments on your debt. (Not sure whether to target the highest interest rate or the smallest balance with the extra cash? Read this for more.)
If you’re going to put extra money towards your debt, though, Brooklyn-based financial planner Pamela Capalad has one thing to say to you: don’t just throw extra money towards your debt willy-nilly. She has seen clients with credit card debt end up with even more debt at the end of the year because they (a.) don’t have savings to fall back on when something unexpected arises and (b.) aren’t being intentional with where and how they’re utilizing extra funds.
“What tends to happen, if you have multiple credit cards, is people will say ‘I’ll put all this money towards these five cards’ – versus systematically eliminating one debt at a time. The biggest thing is to have a clear idea of who much you can put towards the debt every month,” Capalad says.
Eric Roberge, a fee-only financial planner based in Boston, notes that beyond wanting to know how to prioritize their debt, many of the clients he sees (who have student debt) want to know whether or not they should refinance it. His answer: it depends if you’re okay with the trade-offs. “There’s more than just the interest rate to think about,” he says. “When you refinance a federal loan, you’re taking away some of the advantages of having a federal loan, like the ability to defer payments if you run into a hardship.”
Do you have insurance in case something goes wrong? In Becker’s 13-step roadmap, estate planning and insurance planning account for the steps immediately following “build your stage 1 emergency fund.” In his view, you need to make sure you have health insurance, life insurance, long-term disability insurance and liability insurance. (The importance of some of these types of insurance depends on whether you’re single or have a family. For more on how to evaluate your insurance needs, read this.)
Becker says that a lot of his clients ask him about saving for a down payment on a home, and he runs him through this insurance checklist before getting to the mortgage talk. This goes double for folks with kids. “Do you have some kind of life insurance, disability insurance, wills, those kinds of things, just to make sure that, whatever happens, there are going to be financial resources available to you and your family?” he says. “That would really be the first priority; I would strongly encourage getting those things in place before you buy a house.”
Do you want to be your own boss? Capalad and Roberge both said they have a lot of clients who want to one day start their own businesses. And both planners say that if this is a goal of yours, you have to be ready to save a lot of money.
The first question people should ask themselves is: “do they have enough savings? A six month runway is critical,” Capalad says. “Have they figured out how little they can live in those first six months to a year?”
Adds Roberge: “Some people say, ‘I want to start a business of my own,’ but you look at their spending and they’re locked up. Their mortgage is high, they have kids and – to them, they see no way to change anything because all of these expenses are fixed. If you’re going to think differently than most people, your budget has to be different than most people.”
What matters most to you? This is touchy-feely, but true: if you don’t know what matters to you, you’re going to have a hard time prioritizing how you use your money.
“It comes down to emotions and what will motivate you. If paying down all your debt isn’t going to motivate you because it feels like you’re limiting your life, yeah, use some money for debt and some for a goal,” Roberge says, noting that asking yourself ‘Will I regret this?’ can be a good way to assess whether or not to use your money in a certain way.
Capalad also emphasized the importance of feelings and money. “It’s better to save for a feeling than a thing,” she says. “You don’t need to know the thing you’re saving for, but to know you can get out of a bind at any point without going into credit card debt, that is so empowering… It’s not, ‘I want to save for this thing,’ it’s, ‘I want to say yes to this thing.’”
And, finally, some words of reassurance: You’ve probably heard the saying about the perfect being the enemy of the good. This is as true in personal finance as it is anywhere else.
“Understand that you’re young, and it’s more about building habits than it is about doing things exactly right,” says Roberge. “If you’re looking at buying home someday down the road and not in the near future, don’t worry about that goal right now. Make sure you’re paying the minimums on your student loans [and covering your basic needs]. If you’re doing that, you’re in good shape.”
“I think there’s a lot of stress in feeling like you have to make the best decisions every time, and I think that’s a big obstacle to making progress. The truth is there is no best decision,” says Becker. “Instead of stressing over whether to make the best decision, start with what it is you care about, what are your goals, what kind of life are you working towards, and make decisions that are good enough to get you there. There may be an optimal decision between using a Roth IRA or traditional IRA, for example, but they’re both good decisions – contributing to either one is good enough. I wouldn’t put too much pressure on yourself.”
With more than half of U.S. taxpayers expected to receive a tax refund this year and the average refund clocking in at $3,120, it’s safe to say that a sizable number or people have a bit of a windfall coming their way soon (if not already). And if you are part of this group – or if you’ve recently benefited from a different type of cash infusion, like a raise or even a drastic cut in spending – you might be wondering: what should I do with this extra money?
The short answer to these questions is, before all else, save. Every financial planner interviewed for this article said that if you aren’t sure where to put your money, start by making sure you have basic emergency savings in place. As one planner once told me, “Paying down student loans isn’t going to help you when that emergency comes up.”
Beyond basic savings, the precise order-of-operations gets a little fuzzy. Personal finance is more art than science, and how you structure that art depends on you – your life, your goals, your priorities. However, there are some questions you can ask yourself to make sure your money is generally flowing in the right direction. Here’s what you should consider:
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According to Becker’s hierarchy, focusing on building a bigger emergency fund (one with six or more months’ worth of expenses) should only come after you’ve purchased necessary insurance (more on that in a second), contributed to your 401k up to your employer match and paid off high-interest debt.
Are you missing free money at work? In other words: does your employer offer a 401k match, and are you getting it? If the answers to those questions are “yes,” and then “no,” you’re missing out on free money. See how much your employer matches (for instance, full match up to 3% of salary) and contribute enough to your 401k that you can nab the full match.
Is your debt load (a.) high interest or (b.) causing you to lose sleep? If you answered yes to either question and your savings are in decent shape, consider kicking any spare cash flow to paying more than the monthly minimum payments on your debt. (Not sure whether to target the highest interest rate or the smallest balance with the extra cash? Read this for more.)
If you’re going to put extra money towards your debt, though, Brooklyn-based financial planner Pamela Capalad has one thing to say to you: don’t just throw extra money towards your debt willy-nilly. She has seen clients with credit card debt end up with even more debt at the end of the year because they (a.) don’t have savings to fall back on when something unexpected arises and (b.) aren’t being intentional with where and how they’re utilizing extra funds.
“What tends to happen, if you have multiple credit cards, is people will say ‘I’ll put all this money towards these five cards’ – versus systematically eliminating one debt at a time. The biggest thing is to have a clear idea of who much you can put towards the debt every month,” Capalad says.
Eric Roberge, a fee-only financial planner based in Boston, notes that beyond wanting to know how to prioritize their debt, many of the clients he sees (who have student debt) want to know whether or not they should refinance it. His answer: it depends if you’re okay with the trade-offs. “There’s more than just the interest rate to think about,” he says. “When you refinance a federal loan, you’re taking away some of the advantages of having a federal loan, like the ability to defer payments if you run into a hardship.”
Do you have insurance in case something goes wrong? In Becker’s 13-step roadmap, estate planning and insurance planning account for the steps immediately following “build your stage 1 emergency fund.” In his view, you need to make sure you have health insurance, life insurance, long-term disability insurance and liability insurance. (The importance of some of these types of insurance depends on whether you’re single or have a family. For more on how to evaluate your insurance needs, read this.)
Becker says that a lot of his clients ask him about saving for a down payment on a home, and he runs him through this insurance checklist before getting to the mortgage talk. This goes double for folks with kids. “Do you have some kind of life insurance, disability insurance, wills, those kinds of things, just to make sure that, whatever happens, there are going to be financial resources available to you and your family?” he says. “That would really be the first priority; I would strongly encourage getting those things in place before you buy a house.”
Do you want to be your own boss? Capalad and Roberge both said they have a lot of clients who want to one day start their own businesses. And both planners say that if this is a goal of yours, you have to be ready to save a lot of money.
The first question people should ask themselves is: “do they have enough savings? A six month runway is critical,” Capalad says. “Have they figured out how little they can live in those first six months to a year?”
Adds Roberge: “Some people say, ‘I want to start a business of my own,’ but you look at their spending and they’re locked up. Their mortgage is high, they have kids and – to them, they see no way to change anything because all of these expenses are fixed. If you’re going to think differently than most people, your budget has to be different than most people.”
What matters most to you? This is touchy-feely, but true: if you don’t know what matters to you, you’re going to have a hard time prioritizing how you use your money.
“It comes down to emotions and what will motivate you. If paying down all your debt isn’t going to motivate you because it feels like you’re limiting your life, yeah, use some money for debt and some for a goal,” Roberge says, noting that asking yourself ‘Will I regret this?’ can be a good way to assess whether or not to use your money in a certain way.
Capalad also emphasized the importance of feelings and money. “It’s better to save for a feeling than a thing,” she says. “You don’t need to know the thing you’re saving for, but to know you can get out of a bind at any point without going into credit card debt, that is so empowering… It’s not, ‘I want to save for this thing,’ it’s, ‘I want to say yes to this thing.’”
And, finally, some words of reassurance: You’ve probably heard the saying about the perfect being the enemy of the good. This is as true in personal finance as it is anywhere else.
“Understand that you’re young, and it’s more about building habits than it is about doing things exactly right,” says Roberge. “If you’re looking at buying home someday down the road and not in the near future, don’t worry about that goal right now. Make sure you’re paying the minimums on your student loans [and covering your basic needs]. If you’re doing that, you’re in good shape.”
“I think there’s a lot of stress in feeling like you have to make the best decisions every time, and I think that’s a big obstacle to making progress. The truth is there is no best decision,” says Becker. “Instead of stressing over whether to make the best decision, start with what it is you care about, what are your goals, what kind of life are you working towards, and make decisions that are good enough to get you there. There may be an optimal decision between using a Roth IRA or traditional IRA, for example, but they’re both good decisions – contributing to either one is good enough. I wouldn’t put too much pressure on yourself.”
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