The Top Three Priorities For Savings

Emergency funds, retirement, debt payoff, college costs - overwhelming is an understatement when it comes to how we should prioritize our savings. We know we should be saving, but where and how much? The good news is if you are stressing about whether or not you are saving in the "right way" - at least you are saving! Exactly how you should prioritize depends on your specific financial situation. While some financial experts may disagree on the order, most would agree the below three are the top priorities for saving. And it doesn't have to be all or nothing; you can allocate your savings such as a 60%/30%/10% split between the below. Use this guide to evaluate what you have, where you need to beef up your savings, and where you don't.

Top priorities:

1. Emergency Fund: You have to have an emergency fund in case you lose your job, get sick or have a major financial expense. Most experts say you should have three to six months of income saved in cash. If you are in a niche field or small market without many opportunities, you should have closer to six months. If your skills translate across multiple jobs and markets, making you easily employable, than you can probably have three months savings. An important point is your emergency fund needs to be in cash or cash equivalents; it should not include investments, real estate or other assets you would have to sell. Your emergency fund needs to be liquid and easily accessible. Need help getting started? Here are suggestions on how to grow an emergency fund.
2. Retirement: This squeaks by as a close second. Social Security may provide some retirement income, but most need more. You should save at least 15% of your income toward retirement. If you are older and need to save more than 15% but have maxed out your 401(k), you can add to your IRA (ROTH or Traditional). If you need more savings but have exhausted all available retirement options, invest in a tax efficient index fund. You won't get the full tax advantages of a retirement account, but in general index funds are more tax-efficient than actively-managed funds. Index funds passively track a benchmark index, which means low turnover (buying and selling securities) within the fund and less capital gains to pay taxes on than actively managed funds. The Vanguard S&P 500 is one of the best known index funds, and a smart, inexpensive way to invest.  More on tax saving index funds can be found on Vanguard's website.
3. Debt repayment: This is where it gets tricky. If you have $30,000 on a high interest credit card, this may need to be your top priority. If that's the case, maybe keep only $1,000 on hand for emergencies, save less toward retirement, and allocate the majority to paying off those cards. However, if you have low interest student loans, you can pay a little more than the minimum, while still focusing on increasing emergency funds and retirement. The balance provides a step by step guide to creating a debt payoff plan.

There are clearly countless ways to spend and save money. However, the big three should be the top priorities. Once you feel comfortable with what you are saving on the above, then you can start tackling other priorities such as the below:

• Education Funds: If you have kids, I know that their college costs are weighing on you like an 800 lb highly educated gorilla. And it may seem to make sense to prioritize their college fund before retirement because it comes first. However this can be a costly mistake. I know, putting yourself first is a hard concept to grasp for most parents. If you are like me, and every other parent I know, you haven't put yourself first in years. "Oh sweetie, you want my measly granola bar that I was going to eat for dinner? Even though you ate a pound of delicious pasta and meatballs 10 minutes ago for dinner, and I haven't had a full meal in seven years? Of course, take it. If you're happy, than I'm happy." Try to think of it as the airplane safety lecture. The adult first places the oxygen mask on their face before putting the mask on their child. You can't help anyone if you are not healthy, whether it's physical or financial. And, although not ideal, your kids can take out student loans if you have not saved enough. You do not have the option to take out a retirement loan. And for those parents who still can't stop the punishing self sacrifice for their children, think about it this way - if you don't have money to take care of yourself in retirement, your kids will have to take care of you!
• Early mortgage payoff: I frequently get asked if paying off a mortgage early is a good idea. The answer is yes, that's a great idea! The caveat is, as long as you've funded the above priorities and have extra money laying around. Most mortgage are low interest, 30-year loans. Your monthly expense is not going to increase with time, so there's no risk. Also, more than likely you can earn a higher interest rate investing that money versus paying off a low interest loan - meaning more wealth for you.