Get the easy money first. For most people, that means tax-advantaged accounts such as a 401(k). If your employer offers a match, contribute at least enough to grab the maximum. It’s free money.Why do we make capturing an employer match a higher priority than debts? Because you won’t get another chance this big at free money, tax breaks, and compound interest. Ultimately, you have a better shot at building wealth by getting in the habit of regular long-term savings.
You don’t get a second chance at capturing the power of compound interest. Every $1,000 you don’t put away when you’re in your 20s could be $20,000 less you have at retirement.
Priority No. 3 is a toxic debt. Once you’ve snagged a match on a 401(k), if available, go after the toxic debt in your life: high-interest credit card debt, personal and payday loans, title loans, and rent-to-own payments. All carry interest rates so high that you end up repaying two or three times what you borrowed.If either of the following situations applies to you, investigate options for debt relief, which can include bankruptcy or debt management plans:
- You can’t repay your unsecured debt — credit cards, medical bills, personal loans — within five years, even with drastic spending cuts.
- Your unpaid unsecured debt, in total, equals half or more of your gross income.
Priority No. 4 is, again, saving for retirement.
Once you’ve knocked off any toxic debt, the next task is to get yourself on track for retirement. Aim to save 15% of your gross income; that includes your company match if there is one. If you’re young, consider funding a Roth individual retirement account after you capture the company match. Once you hit the contribution limit on the IRA, return to your 401(k) and maximize your contribution there.
Priority No. 5 is, again, your emergency fund.
Regular contributions can help you build up to three to six months’ worth of living expenses. You shouldn’t expect steady progress because emergencies happen, but at least you’ll be able to manage them.
Priority No. 6 is debt repayment.
These are payments beyond the minimum required to pay off your remaining debt.If you’ve already paid off your most toxic debt, what’s left is probably lower-rate, often tax-deductible debt (such as your mortgage). You should tackle these only after you’ve gotten your other financial ducks in a row.
Any wiggle room you have here comes from the money available for wants or from saving on your necessities, not your emergency fund and retirement savings.
Priority No. 7 is you.
Congratulations! You’re in a great position — a really great position — if you’ve built an emergency fund, paid off toxic debt and are socking away 15% toward a retirement nest egg. You’ve built a habit of saving that gives you immense financial flexibility. Don’t give up now.If you’ve reached this happy point, consider saving for irregular expenses that aren’t emergencies, such as a new roof or your next car. Those expenses will come no matter what, and it’s better to save for them than borrow.