How to decide your next best financial action

After most webinars or livestreams, regardless of the topic, the most common questions boil down to one underlying concern. What should I prioritize in my financial life? This underlying concern can present itself in a variety of ways, but here are some of the most common:?

• Should I build my savings or pay down debt??
• Should I make extra payments on my debt or invest for retirement??
• Should I save for my kid’s college or my retirement??

The list could go on and on. If you’ve been curious about these types of tradeoffs, then this article is for you. Below, I am going to outline a simple framework for how you can decide your next best financial action, along with some helpful tips to help you make progress at each step.

Build a safety net

A safety net is one month’s worth of expenses set aside in checking or savings. This is the foundation of your personal finances and takes priority over everything else, including paying down credit cards or investing for retirement. Financially, your safety net serves as the buffer between unexpected events and financial disaster such as racking up bad debt or tapping into retirement accounts while paying taxes, penalties, and potentially selling in a down market. Emotionally, having enough cash to cover basic unexpected expenses has a powerful connection to financial stress, anxiety, and satisfaction.?

If you are focusing on building your safety net, here are some helpful tips:?

• Review your spending over the last three to six months to identify ways to reduce your expenses. Sometimes these cuts will be easy, like canceling unused subscriptions, but sometimes these cuts will be difficult, like taking a break from dining out.
• Stop using credit cards. Period. Credit cards subconsciously cause you to spend more money, which is simply not worth the convenience or rewards at this stage.
• Leverage technology to track your saving and spending. Digital money management tools are simple yet powerful tools that help people change their financial behavior. Some of this change comes from simply understanding your finances and some of this change comes from the targeted insights that are included in a majority of these tools.

Take advantage of your employer’s match

Taking advantage of your employer’s match means that you are fully maximizing the matching contributions your employer will make to your retirement based on your own contributions. This is free money. It is extremely rare that you can use the words “free” and “money” in the same sentence. Sometimes your employer’s match is modest, while other times it is extremely generous. In either case, you should never underestimate the long-term impact of recurring contributions to your retirement accounts.

If you are focusing on taking advantage of your employer’s match, here are some helpful tips:

• Review your benefits package so you fully understand how your employer’s match works. Generally, the match is based on 401(k) contributions, but sometimes it can be based on student loan payments as well.
• Start small and set up automatic increases until you reach the full match. Just because you cannot take full advantage of your match right away does not mean you should wait.

Protect your income

Protecting your income means you have enough disability and life insurance, if you have dependents, to maintain your lifestyle if something happens. Your ability to earn income will drive your path towards financial independence, and protecting your income against getting sick, injured, or a premature death is important. It is also worth noting that protecting your income is often much more affordable than most expect, so this should not break the bank.

If you are focusing on protecting your income, here are some helpful tips:

• Understand and take full advantage of your employee benefits. Many times disability and life insurance offered in your benefits is a fantastic start but might not be enough.
• If you are in the market for life insurance, buy term insurance. Whole life insurance, or other types of permanent insurance, is not the best solution for 99.99% of the people, except for the person selling you the policy.

Attack “bad” debt with a plan

“Bad” debt is any debt that has an interest rate greater than 7%. The reason for the 7% line in the sand is because 7% is the long-term inflation adjusted historical return of the stock market, as measured by the S&P 500 going back to the Great Depression. So if the interest rate on your debt is greater than 7%, paying it off sooner will earn a higher return than what you can expect to earn by investing that money in the stock market. Any debt with an interest rate less than 7% can wait for a bit.

If you are focusing on attacking “bad” debt, here are some helpful tips:

• Use the snowball method. Make a list of your “bad” debt and rank it from the lowest balance to the highest balance. Focus on making extra payments on the “bad” debt with the lowest balance while maintaining minimum payments on all other debt. Once that account is gone, roll that entire amount to the “bad” debt with the next lowest balance. Then rinse and repeat until your “bad” debt is gone.
• Consider ways to speed up your debt paydown through personal loans, 401k loans, or tapping into home equity. But if you take this approach, you absolutely must stop spending on your credit cards or you risk having new debt on top of your credit card debt in a year or two.

Build an emergency fund

An emergency fund is three to six months’ worth of expenses set aside in checking or savings. This is just a larger version of the safety net. An emergency fund can truly provide peace of mind because it allows you to handle major unexpected expenses, job losses, or even leaving a job you hate without digging yourself into a financial hole. Target three months if you are single with a stable income or in a dual income household. Target six months if you are single with a volatile income or in a single income household.?

If you are focusing on building your emergency fund, here are some helpful tips:

• Do not invest your emergency fund. You never know when an emergency will happen, so you want this money to be safe and liquid.
• Explore ways to maximize the interest you earn. Just because you don’t invest this money doesn’t mean it shouldn’t grow. There are plenty of digital banks that offer a competitive APY that could serve as a great place for an emergency fund.
• Automate your savings as much as possible. Automation allows you to make a good decision once and reap the rewards in the future. This can be down by directing a portion of your paycheck or making recurring transfers from your checking account to a separate savings account.

Save 15% for retirement

Saving 15% of your income for retirement is really the baseline to maintain your lifestyle, assuming you start saving at a relatively young age and stop working at a normal age. If you start saving later, earn a high income, or want to retire early, this amount will need to be higher. Sometimes people ignore retirement because it is so far away or they cannot see themselves not working, but do your future self a favor by having the option.

If you are focusing on saving for retirement, here are some helpful tips:

• Take advantage of tax-advantaged vehicles first. Common tax-advantaged ways to save for retirement are a 401(k), IRA, and HSA. This money is going to grow for a while, so you want to be tax-efficient whenever possible.
• Have a long-term perspective when you invest your money. Your investment approach should be based on your ability to deal with risk and time horizon. Rather than stressing about every down day in the market, zoom out and focus on the long-term.
• It is better to be boring than broke. A diversified, low-cost investment portfolio is not as trendy as concentrated positions in individual stocks, cryptocurrency, or even real estate. But a diversified, low-cost approach based on your ability to handle risk and time horizon gets the job done.

Save for other goals

Saving for other goals is going to look different for each person. Once you reach this stage of your finances, you are in a very solid position. Common examples of other goals are saving for a kid’s college, buying a vacation property, building a nest egg for the next generation, or even saving funds to semi-retire rather than waiting to fully retire at 65. The key with other goals is to define the what, when, how much, and how long so you can develop a plan and measure progress accordingly.

If you are focusing on saving for other goals, here are some helpful tips:

• Choose your accounts based on your goals carefully. If you are saving for college, a 529 savings plan can offer compelling tax and financial aid benefits compared to some other types of accounts. If you are saving for major expenses in a few years, you rarely want that money tied up in a tax-advantaged account.
• Make sure you do not skip ahead to this step. This is the most common step people want to skip ahead to, especially for parents. It is absolutely critical to make sure you are in a solid financial position before focusing on other goals.

Pay down “good” debt

“Good” debt is any debt with an interest rate of less than 7%. This threshold goes back to the cost-benefit discussion above. Honestly, classifying debt as “good” debt gets plenty of pushback because the terms “good” and “debt” are rarely used together. This is all based on taking a step back and thinking about the best use of each dollar. For example, it is more efficient to invest extra money rather than making extra payments on a mortgage with a 3% interest rate.??

If you are focusing on paying down “good” debt, here are some helpful tips:

• Consider ways to speed up paying down “good” debt by refinancing it first. Chances are if you are at this stage, you have a solid income and credit score, which may offer the potential to lower your rate at a shorter term to help pay less in interest along the way.
• Explore creative ways to use rewards points or cash-back on credit card spending to pay down “good” debt. Sure, travel rewards are fun but generally unless your spending and point redemption is concentrated, a broad cash-back credit card makes the most sense.

Closing Thoughts

Now you have a good framework to use as a guide when you are debating between one financial priority and another. The key to this framework is to focus on one step at a time and make sure you focus on the right step for your unique financial situation. By focusing on one goal at a time, you will experience progress quicker and progress leads to persistence. By focusing on the right goal at the right time, you will build upon a solid financial foundation to achieve financial independence.