Welcome to the first article in a series dedicated to illustrating ways to prioritize saving for future milestones and the uncertainties of life. In this post, we will explore how to build your Emergency Fund, prioritize your 401(k) contributions to maximize your employer match, and eliminate all high-interest credit card debt.
Successfully building your wealth can feel energizing, and with that success can come new questions and complexity.
To help you visualize some potential next steps, let’s walk through a savings priority strategy. This approach prioritizes sequencing contributions to specific financial needs and their related investment accounts.
This strategy utilizes both tax-advantaged and taxable accounts.
While this strategy can be effective and transformative to your personal finances, like all things personal to your finances, you’ll want to understand what it is and how it can be customized for your specific situation. Nothing here is dogma.
Overview
Ideally, when you use this strategy, you fully fund each priority before turning your attention to the next priority. So, start with the first priority and when it’s fully funded, move on to Priority 2, then Priority 3, and so on.
While this strategy specifically refers to how to attack debt and invest for retirement, it can incorporate saving for major purchases such as a vacation home, a child’s wedding, or other financial goals. It should be incorporated into your comprehensive financial plan. Depending on your goals and personal situation, the order of these priorities can change.
Let’s dive into this savings priority strategy and begin to help you organize what comes next.
Learning Points
Emergency Fund
Start by saving one to three months’ worth of living expenses. Prioritize Liquidity. You can help dampen the financial shocks of unforeseen events by creating and funding your emergency fund. Catastrophic events could happen to your health, the health of a family member, your home, vehicle, or other asset. While proper insurance coverage can help shift some amount of your risk it is often not cost-effective to completely protect you against those losses. That’s where the emergency fund can, at least initially, be the financial cushion you need when something in your life does not go according to plan.
Your emergency savings fund can help you avoid high-interest consumer debt (i.e., credit card debt) and provide you with the comfort and confidence that you have financial breathing room in case unexpected risks happen.
Remember, liquidity is the most important feature to prioritize in the emergency fund savings account. That feature aligns well with savings-type vehicles. In my experience, emergencies do not announce themselves in advance.
Here are some other practical ways to build your emergency fund:
- Use a mobile banking app to manage your emergency fund. This can make it easier to transfer money between accounts and track your spending. It helps with automating your savings. More on that later.
- Consider using a debit card linked to your emergency fund account. This can allow you to make purchases or withdraw cash as needed.
- Set up automatic transfers from your checking account to your emergency fund account. This can help you consistently save and build up your emergency fund over time. More on this concept in a future post…
- Consider using a cash-back rewards credit card for everyday purchases, and depositing the rewards into your emergency fund. Just be sure to pay off the balance in full each month to avoid paying credit card interest.
- It’s also helpful to keep some cash on hand for emergencies, such as in a fireproof safe or hidden in a secure location in your home. Just be sure to keep track of the cash and update your emergency fund balance accordingly.
Company Match Available Through Your Employee Retirement Plan
This is a benefit that many companies offer their employees and one that you should try to maximize each year. Specifically, if your employer offers this benefit, the employer is incentivizing your retirement savings. How?
By matching a percentage of your salary that you contribute to the company retirement plan up to a specific dollar amount.
- Traditional matching contribution: Under this design, the employer matches a certain percentage of the employee’s contribution, up to a certain limit. For example, an employer might offer a 50% match on the first 6% of an employee’s salary that the employee contributes to their retirement plan.
- Graduated matching contribution: Under this design, the employer’s match increases as the employee’s contribution level increases. For example, the employer might offer a 50% match on the first 3% of an employee’s salary, and a 75% match on the next 3%.
In any case, give yourself a predetermined rate of return by maximizing those matching contributions from your employer. If not, you are leaving free money on the table.
Credit Card Debt. Pay It All Off
High interest rates can make it challenging to build wealth in the long term, so it is important to prioritize paying off all your credit card debt.
While paying down credit card debt can be difficult, there are several strategies that can help you make progress:
- The debt avalanche method: With this method, you focus on paying off the credit card with the highest interest rate first, while making the minimum payments on your other cards. Once you’ve fully paid off the next card with the highest interest rate, you then fully pay off the card with the next highest interest rate. This process repeats until all of your credit card debt it paid off. This method prioritizes paying the least amount of interest over the long term.
- The debt snowball method: With this method, you focus on paying off the credit card with the smallest balance first, while making the minimum payments on your other cards. Once the card with the smallest balance is paid off, you can move on to the card with the next smallest balance, and so on, until all of your credit card debt is paid off. This method prioritizes building momentum and staying motivated when you have the resources to pay down your debt. The psychological benefit of making progress should not be underestimated[1]. Relative to the debt avalanche method, this approach could mean that you pay more interest in the long run.
- Consider a balance transfer credit card: If you have a high-interest credit card balance, you may be able to save money on interest by transferring the balance to a credit card with a lower interest rate. Many credit cards offer introductory 0% interest rates on balance transfers for a limited time, which can give you a window of opportunity to pay down your debt without accruing additional interest. Just be sure to read the fine print and understand any fees associated with the balance transfer, and make sure you can pay off the balance before the promotional rate expires.
To help you evaluate the right strategy for you, find a free online calculator (you don’t need to pay for one) that can show you what each approach above means for your specific situation. Develop a plan and stick to it.
Once you pay off credit card debt, pay your full balance each month.
In our next post, we will explore Health Savings Accounts and Insurance.
The Next Step
When you know who and what are truly important, you can create incredible clarity about your spending and saving.
Clarity to confidently spend on things that matter. Clarity to avoid spending your hard-earned resources on things that aren’t aligned with what you want in life.
As your financial planner in Saint Louis, we can help you plan for the future and enjoy the present moment.
Start feeling more confident that you are making progress toward your savings priorities.
When you thoughtfully execute on this approach, you can increase the likelihood of achieving your goals, setting new ones, and enjoying the present moment.
Frequently, proactive and open collaboration with your tax and estate planning professionals can help you work towards your financial planning goals. Working with your financial planner in Saint Louis can provide you with the right mix of accountability, collaboration, and long-term thinking.
If you’re unsure about your next step, let’s talk.
[1] Amabile, T. M., & Pratt, M. G. (2016). The dynamic componential model of creativity and innovation in organizations: Making progress, making meaning. Research in Organizational Behavior, 36, 157–183. https://doi.org/10.1016/j.riob.2016.10.001
Disclosure
This commentary is provided for educational and informational purposes only and should not be construed as investment, tax, or legal advice. The information contained herein has been obtained from sources deemed reliable but is not guaranteed and may become outdated or otherwise superseded without notice. Investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decision.