Personal financial planning is all about setting priorities and then putting your resources to work to achieve them, while covering the big risks that could derail your financial future. The thought is you want to give every dollar that comes into your bank account a job.
Whether you’re a mid-career serial entrepreneur or in your first job out of college, it’s good to be organized about where your savings should go. Here’s my suggested list in order of priority.
- The Piggy Bank. You may be in substantial debt at usurious interest rates or have the investment opportunity of a lifetime. Before you do anything about other savings and investment priorities, I’d like you build up your piggy bank of $1,000. Those of you who are financially successful may scoff at this, but for those just getting going in their savings the first thousand dollars buys them the ability to think about the future rather than worry about today.
- Retirement Plan Match. Most positions come with a 401(k) or other type of work retirement plan with an employer match. A common example is they will match the first 3 percent of annual pay that you contribute to your retirement plan. So if you’re earning $80,000 a year and you’re contributing $2,400 a year into your plan, then your employer will kick in an extra $2,400. If you’re passing this up, then it’s the equivalent of walking past hundred dollar bills on the sidewalk and not taking the trouble to pick them up!
- Pay Off Consumer Debt. If you run credit card balances from month to month, or have a loan from an appliance or furniture store, I’d like you to list out your loans with the balance due, the minimum payment, and the interest rate associated with it. The mathematically correct course here is to pay down your highest interest rate debt first and make minimum payments on the rest. But watching every penny can be exhausting and you may need the endorphins from ridding a creditor from your life. In that case you may want to pay off the lowest balance loan to keep you motivated.
- Save Three Months of Expenses. Now you should build up your reserves beyond the $1,000 and work on a financial fortress equivalent to what you spend over three months. The idea is that financial emergencies become transformed into inconveniences when you have at least 3 months of cash in your account. I recommend you use an online savings account such as Barclays or Ally for this fund. It keeps it out of your checking (where it’s likely to be frittered away) and gets you at least 1 percent interest. This can also be a good seed fund for a down payment on a home, if you don’t already own one.
- Roth IRA and Additional Retirement Savings. Most workers fall in the income guidelines of a Roth IRA, which is an account that allows tax free growth for the rest of your life. Setting up a Roth IRA account at a low cost mutual fund or brokerage company like Schwab or Vanguard allows you to put $5,500 away for each worker each year, with those 50 and over able to contribute $6,500. If you have a low cost work retirement plan, it’s a good idea to increase your contributions beyond the match. If you’re under 50, can put up to $18,000 a year into a 401(k) with those who have turned 50 able to contribute $6,000 more a year. Once you get monthly long-term savings up to 15 percent of your gross salary, then you can move on to the next step.
- Higher Education Savings. If you have children and it’s likely they will go on to college, this is your time to start putting funds away for higher education. Colorado’s CollegeInvest Direct Portfolio 529 plan is run by Vanguard, has good age-based investment options with low costs, and allows for a generous Colorado state income tax deduction. Work on getting one third of the expected cost of higher education into the account. So with today’s college prices if you expect to spend $30,000 a year for your child, work on getting $40,000 into the account (about one-third of four years of higher education). College costs will rise over time but so will the value of the account.
- Good Next Steps. Once you have achieved all of the earlier steps, now you have more discretion about what to do next. Pay off your low interest students loans (the high interest ones went away in step 3), pay off car loans and pay cash for your next car, put aside additional savings, or start paying off your mortgage ahead of schedule. If you reach this step, you’ve gone far beyond most of your heavily indebted colleagues. It may that you become like many of our clients where we encourage them to spend more of their funds on themselves or their favorite charities. I hope you reach this step!