Disclaimer: I am not a trained money professional, so definitely ask a financial advisor, tax accountant, etc. before making any financial moves!
Money is a funny thing because we often have a love hate relationship with it. We say we want more of it, but then we also say things like “money is the root of all evil”. Our beliefs about money start forming from a very young age and it takes active rewiring to change those beliefs. Tragically, with all of the schooling we go through, most schools do not teach any basic financial literacy. We are roughly aware that we need emergency savings, to pay off debt, to save for a house, to save for retirement, etc., but how do we prioritize all of those competing money goals??
There’s actually a fairly straight forward way to logically prioritize where you’re putting your money. What makes it a bit wishy-washy is emotions do come into play and should be respected as part of your decision making process. The overarching decision factor is interest rate. Interest is essentially money paid for money borrowed. You either pay interest on money you borrow (mortgage, student loan, credit card debt) or you get paid interest on money that banks or companies borrow (savings accounts and investments like stocks and bonds). Obviously, we prefer to get paid interest than pay it, which we do by saving and investing more and borrowing less. But what do you do when you’ve borrowed money? Sometimes we’re so excited about saving and investing that we’d rather do that than pay off debt and sometimes we’re so debt averse that we’d rather pay that off than put our money to work elsewhere. Neither of these are the right answer all the time though.
What you want to do is prioritize the highest interest rate, whether it’s being paid or being received. For example, if you have credit card debt, it is likely that your interest rate for that is about 20%. If you are investing in a diversified stock market portfolio, you are historically making an average of 8% in interest. That means you would want to pay off the credit card before putting money into the stock market because 20 is higher than 8. If you have an employer matched 401k, then that equates to a 100% interest rate. There’s pretty much no where else that can guarantee you that large of a return, so you’d want to prioritize that over nearly everything else.
Simple rule, right? But then there’s emotions. If while knowing this rule, you still feel like you would sleep better at night breaking it or would be more motivated towards another goal, then by all means prioritize in a way that will make you most successful. Some people truly hate having debt and so they will be more motivated to throw money at their debt than they would be to save or invest. Do what works for you and what’s in line with your goals! You can also work towards multiple goals at once, but prioritizing is still important so you can reach your higher priorities faster.
A typical money goal prioritization could be something like the following (note that the order can change as interest rates change over time):
- Save ~$500-1000 in an easy to access account (emergency fund for things like car maintenance or random medical bills)
- Contribute maximum that is matched in 401k account (if available)
- Pay off credit card debt (if applicable)
- Save 3-9 months of essential expenses (in case of job loss, based on risk tolerance and your marketability)
- Pay off student loans (if applicable)
- Save for house down payment and/or aim to max out retirement accounts (depending on personal goals)
- Invest in non-retirement investments (stocks, bonds, real estate, etc.)
- Save for kids college plans (if applicable)
- Pay off mortgage (nowadays mortgages typically have much lower interest rates than you could earn in the stock market)
Your Turn: What money goal are you currently prioritizing and why?