If you’re like most Millennials, you have a lot on your plate. (And you’re trying to do it all, too!)
It’s wonderful that you’re so driven, but trying to juggle a bunch of financial priorities at once can quickly get complicated. After all, most of us only have so much cash to go around each month. When we’re working toward more than one financial goal, how do we know what to put at the top of the list as most important?
The answer to question of financial priorities gets more unclear when you have “build up savings” and “pay down debt” as items on the list. Most personal financial advice focuses on stressing one or the other, but doesn’t necessarily explain how to decide your course of action if you want to accomplish both.
First, Build Up Some Savings
How much you actually have saved plays a big role in this decision. There is a big debate among financial gurus in terms of how much you should save before you pay down debt. Some feel you should have at least $1,000 (Dave Ramsey’s baby step #1); others, like Suze Orman, feel like you need eight months of savings.
My answer is somewhere in between.
I feel it’s extremely important to have at least one month of your income in savings before you aggressively begin paying down debt. For example, if your net pay is $1,500 per paycheck and you get paid twice a month, then save at least $3,000 before you start an aggressive debt repayment plan. Eventually, the goal is to build up 3 months of emergency savings after you’ve paid off your high-interest debt.
If you only have a few hundred dollars in savings, keep paying the minimum on your debt until you can set aside some more cash. Otherwise, you’ll be using a credit card for emergencies — and that’s a hard habit to break.
Next, Tackle High-Interest Debt
When you’re deciding how aggressively to tackle your debt, the first thing you have to determine is how much stress that the debt is causing you. For some people, any debt is stressful, no matter the interest rate. They feel like they have to get rid of it as fast as possible. Others are more comfortable carrying some debt, as long as it feels manageable. Everyone is different, so know yourself.
The other important piece of this equation is the interest rate on your debt.
Look at the interest rate attached to your loans, credit cards, or other forms of debt you have. I usually tell my clients that if the interest rate is higher than 5%, we need to create an action plan to eliminate that debt.
Every day that you carry balances on your loans or credit cards, that high interest rate is eating away at the cash you’re working so hard to earn. But once that high-interest debt is gone, you not only free up whatever amount of money you had tied into monthly repayments, but you also stop paying the high cost to borrow money each month.
What To Do With Low-Interest Debt
When I say “low interest rate,” I’m speaking relatively. All debt costs you money, thanks to the interest the lender charges. But if the interest rate is lower than 5%, then over the long term, your investments and retirement savings may earn enough interest to offset the cost of this low-interest debt.
That’s why, if you have debt with interest rates under 5%, consider making contributions to your 401(k) or Roth IRA a financial priority. Contribute at least enough to earn your company match on your 401(k), and then aim to max out your Roth IRA (that’s $6,000 for 2020, which comes out to $500 per month).
Your 20s and 30s are prime savings years, and missing out on the opportunity to put money away now can cost you later. That’s because of the power of compound interest. Because compound interest increases exponentially, your savings are likely to be worth more in the future if you start saving now rather than waiting — even if you were to contribute more later than what you can contribute right now.
Do What You Can with What You Have!
It’s important to just start saving with whatever you can. If you can’t max out your Roth IRA right now, don’t stress. But make it a financial goal to strive for in the future.
At the same time, make sure to make monthly payments on your debt — preferably payments that are above the minimum. Even if you can only pay $100 extra each month on your debt, do it! Every little bit will help you get out of debt faster. Debts with an interest rate of under 5% are more manageable, but at the end of the day, debt is debt — and it’s costing you money.
And when you pay down your debts, be sure to celebrate your victory! It’s hard work and you should be proud of what you accomplished.
If you’re already doing an awesome job paying down debt, building up savings, and starting to invest for retirement, then it might be time to take the next step and start interviewing financial planners to help take you to the next level.