It's quite challenging to choose between paying off debt and saving for the future. For many, the option is between liquidating a mortgage loan and investing for retirement. Indeed, both are praiseworthy objectives, but which one you should give priority to. Delaying retirement savings is not a wise decision, but letting costly debt drain your pockets doesn't make sense either.
Of course, everyone's financial needs are different, but when deciding whether to save for retirement or pay down debts, most financial experts advise opting for the first one. Here we have a step-by-step guide on what to do first to make your money work best for you.
- Concentrate your finance on a retirement/ investing plan
- Settle predatory high-interest debts
- Build a rainy day fund
- Decide on reasonable interest rate funding options
- Have a well-arranged plan, preferably in writing
Prioritize Retirement Saving!
Ideally, you should begin saving in your early twenties, when you first leave school and start earning. In fact, the sooner you start saving, the more time you have to save toward your retirement plan. If you have an employer-sponsored plan (ESP) such as a 401(k), you can take advantage of the free money provided by your employer. Imagine a company you work for matches 100% of your contributions each year, a maximum of 2% of your annual paycheck. So, if you make $70,000 per annum and contribute at least 2% of your income, your employer will add $1,400 to your $1,400 payment each year.
If a company does not provide a retirement plan, opt for a conventional IRA (Individual Retirement Account) or Roth IRA. Actually, there is nothing special with these traditional retirement plans, but the good thing is you may arrange an automatic transfer of funds from your paycheck to a retirement account.
Dispose of High-Interest Debts!
Essentially, you need to take care of your high-interest rate debts, such as payday loans, credit cards, or online cash advances. If your debt exceeds half of your monthly income, prioritize debt relief. You can try the debt snowball technique to provide yourself a psychological boost, focusing on the smallest debt first while making minimum monthly payments on other outstanding debts.
Develop an Emergency Fund!
Establishing an emergency savings account, also known as a rainy day fund, should be one of your initial savings and investing goals. While the primary purpose of investing refers to earning money for the future, the emergency fund is all about protecting yourself in the present. Ideally, a rainy day fund should include enough money to cover three to six months of your household costs (the more, the better).
Don't Overlook Low-interest Debts!
After you've paid off your high-interest debt and established an emergency fund, consider putting more effort toward paying down other loans. Focus on one loan at a time if you have multiple. For example, suppose you have five outstanding loans, each with a $100 minimum monthly payment and a budget of $800 to repay all your debts. It will be wiser to pay $100 for four of them and $400 for the fifth one. Once the fourth one is settled, your total monthly payment would be $400 instead of $500. At first glance, it doesn't make so much sense, but it can save the situation when a financial emergency happens.
Have a Successful Budget in Writing!
Having a well-planned budget is a must if you want to limit your spending and work toward your financial objectives. A budget will show you how much money you plan to come in, then compare that to your necessary costs (like rent and insurance) and discretionary spending (like entertainment or eating out). So instead of seeing a budget as an obstacle, consider it a tool for accomplishing your financial objectives. Always have your budgeting plan in writing as it may help to stay focused on setting financial targets.