One of the most confusing financial decisions facing younger clients and families is prioritization. They are just starting out in life, and the sheer number of financial planning questions and opportunities can overwhelm them into doing nothing or a little bit of everything.
Maybe you have a child or grandchild that is graduating this month and will be facing important financial decisions soon. Or maybe you or your children are still in their 20s or 30s and feeling a bit directionless in your or their financial life.
We find that prioritizing one financial step at a time tends to lead to better results. While every person and every family is different, here are a few general guidelines to use or share to get the financial prioritization thought process:
- Build a cash buffer. Setbacks happen in life. Having a $5,000 emergency fund in the bank offsets some of this risk.
- Take advantage of free money. If your employer matches any portion of your employer retirement plan contributions, take full advantage of it. Nothing compares with an immediate 25% to 100% boost to your retirement savings.
- Pay off expensive debt. Pay off any non-mortgage debt charging you more than 6% interest. Just as matching retirement plan contributions boost your finances, corrosive debt gradually eats away at your financial health. Paying down debt can improve your cash flow, financial flexibility, and credit worthiness.
- Save for future large expenses. The only thing better than paying off debt as soon as possible is avoiding it in the first place. Companies will try to convince you to buy expensive things you do not need right now by making the monthly payment affordable. Never ever use monthly payments as a gauge of affordability because it disguises your real cost. It is much better to make the required “monthly payments” to your bank account and then pay cash when you have enough saved. This has the ancillary benefit of correctly differentiating between your needs and your wants. It may be tough initially, but this should also apply to your vehicle purchases.
- If you are eligible to make contributions to a Health Savings Account (HSAs), make the maximum contribution over the course of the year. HSAs are one of the best-kept secrets for retirement savings. You get BOTH a tax deduction for your contribution AND distributions for qualifying health-related expenses are tax-free. Consider accumulating assets in your HSA for retirement instead of using it for ongoing medical expenses.
- Build a bigger cash buffer. Having a $10,000 emergency fund (in addition to your planned savings) is roughly twice as much fun as having a $5,000 emergency fund.
- Increase your retirement plan contributions to 15% of your income. Your tax professional can help you make the optimal decision for your circumstances. In general, we suggest making Roth contributions (either 401(k) or Roth IRA) if you are in one of the bottom two federal tax brackets. If you are in a higher tax bracket, we generally recommend traditional (tax deductible) retirement plan contributions. Your specific strategy may be different depending on your tax professional’s assumptions regarding your future income tax rates.
- Have some fun. You are welcome to boost your retirement savings further, but maybe this is the time to let your hair down for a bit and have some fun. Insert your own definition of fun here.
While these steps work for many people, every person and every family is unique. Whether you are in your 20s or in your 50s, we are happy to help you prioritize for your financial future.
Quote of the week: Lee Iacocco: “To succeed today, you have to set priorities.”