This was originally published on Monday, January 30, 2017, in the Pacific Daily News. Click here to subscribe to the PDN.
If you are like most Americans, you have debt to pay off, an emergency fund to build up, and a retirement for which to save. Many people find their budget is quite tight because their monthly debt payments are closer to 20 percent to 25 percent of their net income, versus the recommended 5 percent to 15 percent.
So what should you do?
There has been a long debate between financial experts on whether to pay down debt first or start a savings account. On one hand, paying down high interest rates is simple math. Most interest rates on loans and credit cards far exceed the interest you earn on a savings account. If your interest rate is higher on your debt than the interest you earn on your savings, you are basically losing money. On the other hand, if you don’t save and don’t have an emergency fund, you may be forced to take a loan later, which causes you to take on more debt.
The answer isn’t simple and is based on your individual situation. These are some general guidelines to consider when setting your priorities.
- Emergency savings. At the minimum, you should put at least $1,000 in savings for a rainy day. Keep it in a savings account and use it only for genuine emergencies. A genuine emergency is a something you may not expect to happen and usually takes you by surprise — a home/car repair, health emergency, loss of a job, etc. Continuously add any amount you can to this account.
- Max and match your employer’s retirement plan. Start putting money into your retirement account. It is imperative to max out contributions for those closer to retirement. Don’t take money out of your account until you are ready to retire. You can use a retirement calculator online to see if what you have saved is in line with what you should have saved. If not, start saving more. If you receive a raise, start saving that percentage toward your retirement.
- Start paying off debt. Start with the debt with the smallest balance. Continue to pay on the larger debts. Once the balance on the smaller debt is paid off, put the amount you were paying on the previous debt and add that to the next debt with the smallest amount. Continue this pattern until you are debt free. If you have a home and that is the largest debt you owe, move all the payments you would have been paying on those smaller loans and apply them to your mortgage. Be sure additional payments go to reduce the principle. The interest is based on the amount of the principle; lower the principle, lower the interest paid.
- Save for college. If you have a student getting ready for college, you may feel obliged to start saving. Although it is commendable, as much as we want to help it may not be possible. Your student has many opportunities to apply for grants or scholarships, you have daily bills, savings and one retirement in which to save.
Check with your employer to see if they offer scholarships for children of employees. If you have a sizable savings, have paid off most of your debt and are on track to retire, then helping your child get an education is possible. Otherwise, stick to your financial goals.
Just like any other financial advice that I offer, what you do is based on your specific situation. What works for one household may not work for another. What matters the most is you achieve your financial goals.
Michael Camacho is president and chief executive officer of Personal Finance Center. He has more than 20 years of experience in retail banking and at financial institutions in Guam and Hawaii. If there is a topic you’d like Michael to cover, please email him at firstname.lastname@example.org and read past columns at the Money Matters blog at www.moneymattersguam.wordpress.com.