How Do I Prioritize My Financial Goals?
Goals are important! They keep us organized, motivate us, and act as stepping-stones to our ultimate destination. Unfortunately, sometimes we have so many goals, it can be difficult to determine where to focus our efforts first. What should come first, saving for retirement, paying off debt, building up an emergency fund or saving for kid’s college educations? What if I want to save up for a down payment on a new home? If you try to do too much at once, you can almost enter financial paralysis, barely making a dent in any of your financial goal endeavors. So, what should you do first?
Get Organized and Know Your Numbers
How much do you make? How much do you spend? If you don’t know these two figures, it will be extremely difficult to have an effective strategy for prioritizing financial goals. Create a budget/cash flow projection, which shows income and expenses per month. Consider using an app like Mint to track/categorize your spending and view your financial accounts all in one place. Once you have done this, you can determine how much money you have available to set aside for goals. Many people like the 50-30-20 rule, which advises allocating 50% of your net income to needs, 30% to wants and 20% to savings/ financial goals.
Review your insurance policies so you can ensure you have adequate insurance coverage. This pertains to health, property, and casualty (auto/home), disability insurance and life insurance. Long-term care insurance should be considered for those with substantial assets since Medicare and other health insurance policies don’t cover long term care and Medicaid requires that you spend down most of your assets. In a nutshell, being underinsured exposes you to large, unwanted expenses.
Control Your Spending
Consider using cash for any discretionary (non-essential) needs; this will keep you in check. Deduct a specified amount each month or per paycheck and stick to only using that amount. Take the time to review your credit card statements and your bills. Are there any charges that you can get rid of? Perhaps you no longer need that subscription or a plan with a smaller price point would suffice.
Emergency Fund Savings
These next two categories are neck and neck, meaning there are valid arguments for both being next in the priority line. The rule of thumb is that you should save up enough money to cover three to six months’ worth of living expenses in case of a layoff, injury, or other emergency. Do what you can. Start with $500 or $1,000 and build on it each month until you hit your target. Keep your emergency fund somewhere it is FDIC insured such as a savings account or better yet, an online high -yield savings account would be ideal. This pandemic has revealed many truths to us, one of which is the necessity of an emergency fund.
Pay off High-interest Rate Debt
High – rate debt is a nemesis to financial success. Focus on paying off any debts with interest rates above 7%. Paying down debt is a guaranteed, tax -free return equivalent to the interest on that debt. Most credit card rates are upwards of 15% or even higher. Some prefer to pay down debt before building up an emergency fund. CNBC does an excellent job of explaining the benefit of doing so. “If you had a credit card balance of $6,194 and were charged a 15.78% interest rate, paying only $200/month toward that debt would take you over three years to pay off the credit card. In that time, you would spend $1,812 in interest alone for a grand total of $8,006. If you instead used that monthly $200 payment toward building an emergency fund from scratch in a high-yield savings, such as Varo with an APY of 1.21%, three years would yield you a lesser $7,336 total- not to mention, you’d still have debt.” Paying down your credit card balances also improves your credit score since it lowers your credit utilization rate, which accounts for 30% of a credit score on the FICO model.
Saving for Retirement
Are you already contributing to your retirement in a company 401(k) or 403(b)? Perhaps you are self-employed contributing to a SEP IRA, traditional IRA, or ROTH? If you haven’t started, you should! Even while you are paying down debt and building your emergency fund, you should be contributing at least something into these accounts to gain the advantage of compounding; a gift from “Father Time.” The younger you are, the more generous the gift. If you have a company 401(k) or 403(b), and your company is willing to match a portion of your contributions, DO IT! Where else are you going to get free money? Contribute enough to get the employer match, which in many cases is up to 6% of salary. If you don’t have access to a 401(k) or 403(b), set up an IRA and begin making monthly contributions. You can set them up to be automatically deducted from your checking account. Starting out your contributions may be small; that’s okay. Structure it so that you increase them every year until eventually you are contributing at least 15% of your salary towards your retirement accounts.
Some people make the mistake of applying extra funds towards their mortgage principal before saving for retirement. Doing things in this order contradicts one of the primary tenets of investing; the earlier or longer you invest, the more opportunity for your money to grow. If you focus on paying down the mortgage prior to investing for your retirement, you are losing out on the power of compounding compliments of “Father Time.” Even with increased contributions to your retirement accounts, it will be extremely difficult to make up for that lost time. Of course, paying down your mortgage is a good idea if you have the extra means of doing so. If you are in a situation where you can simultaneously do both, then go for it. A good rule of thumb to follow is start paying down your mortgage loan after you have begun contributing 15% of your income towards your retirement savings.
Pay off Lower-interest Rate Debt
Any debts with an interest rate of 7% or less, should be chipped away at now. This could be things like student loans, auto loans or credit cards. Another option is to refinance any high-rate loans. For many people, the term “refinance” goes hand in hand with mortgage, but other loans such as student loans and auto loans can also be refinanced to a lower rate. Be careful, though, that you don’t take a longer- term loan to replace the current one.
Saving for a Down Payment
Credit scores are crucial when you are trying to purchase a home. That is why paying off your high interest debt first is important. By doing so, you will have improved your credit score and lowered your debt-to-income ratio. Private mortgage insurance (PMI) is an added cost to many homeowners when they purchase their first home. To avoid PMI, you will need a down payment of at least 20% of the value of the home. If you cannot afford 20% and must use a lesser amount, you will pay PMI until the loan to value (LTV) of the mortgage reaches 78%, and the PMI can be removed.
Prioritizing goals does not have to be overwhelming and stressful. An individual’s specific financial circumstances, taxes and needs/wants/wishes are all powerful drivers in determining the best course of action. Meeting with a financial advisor can help you develop the plan that is right for you. Give us a call at (410)840-9200 to start a conversation or visit us at www.mainstadvisors.com
Motley Fool. (January 2020). How to Prioritize Your Financial Goals. https://www.fool.com/investing/2020/01/16/how-to-prioritize-your-financial-goals-in-2020.aspx
Nerd Wallet. (December 2019). Financial Goals: Where to Begin? https://www.nerdwallet.com/article/investing/financial-goals
Forbes. (June 2018). How to Prioritize Your Financial Goals. https://www.forbes.com/sites/financialfinesse/2018/06/25/how-to-prioritize-your-financial-goals/?sh=40a666906d97
Acorns. (January 2021). Save First, Then Pay Down Debt? Or Go the Other Way? Here’s How to Prioritize Financial Goals. https://grow.acorns.com/prioritizing-financial-goals/
Main Street Advisors, LLC. March 2021. Main Street Advisors, Inc. is a Registered Investment Advisor. The articles and opinions expressed in this material were gathered from a variety of sources, but are reviewed by Main Street Advisors, LLC, prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of March 2021 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual situation. Always contact your financial/investment professional before making any financial decisions. Main Street Advisors, LLC is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.