How to Prioritize Your Money Goals
One of the most common questions I hear is: “What should I do first with my money?” Should we pay off student loans before investing in a 401(k)? Should we pay off high interest credit card debt before building a rainy day fund?
This is a really important question. If you got a tax refund or bonus check tomorrow, would you feel confident about knowing where to allocate your money? Most of us have multiple financial goals, but contributing to all of them at once isn’t practical.
In trying to achieve all of our goals at once, our progress on each goal will be small (and therefore not motivating!). This also doesn’t take into account which goals are most important. We want to prioritize our goals by considering which ones are most important to us, are the most urgent, or are more timely.
How do we decide which comes first?
In a lot of cases, the answer is annoying: it depends on a bunch of things. Here I’ll share factors to consider when prioritizing your own financial goals.
First and foremost - SOME rainy day fund.
We want to have some savings set aside for a rainy day or emergency, even if you have high interest credit card debt. When we prioritize our credit card debt over having any savings, and something unexpected comes up, we’re stuck putting it on a credit card and there are still things and situations where we need cash. All of our expenses can’t go on a credit card.
There’s also something really important about changing the way we operate and switching how we operate moving forward. By contributing to our rainy day fund, we become savers. We also have to create the space for it by setting up an account and transferring money over, no matter how small the amount.
Now, the key thing here to remember is that it doesn’t have to be your full rainy day fund. A lot of financial experts recommend getting $1,000 saved up before prioritizing anything else. You might also want to think about some of the bills you need to pay for in cash.
Why the resistance?
Many of us resist doing this because we don’t believe that we’ll actually be able to put aside money for a rainy day. We haven’t been successful at saving in the past, so we’d rather put the money towards our credit cards where we can see the progress. I hear you and I get it.
After we understand why it’s important to prioritize a partial rainy day fund over all else, we can consider the rest of our goals.
Here’s how to prioritize the rest.
Investing vs. 401(k)
There are a few reasons it makes sense to prioritize investing in our 401(k)s before investing on our own in a brokerage account. Employer match is a biggie! If our employers are offering 401(k) match, that means they’ll match our contributions up to a certain percentage. We put in 3% and they’ll put in 3%. That’s free money!
Even if our companies don’t offer 401(k) matching, it makes sense to put money into our 401(k) because there are major tax advantages. In a typical investment account, we pay taxes on the amount our investment grows (called capital gains). In a retirement account - like a 401(k) or IRA - our money grows tax-free.
The money that we put in our retirement accounts should be viewed as untouchable (for now). Other than a few exceptions, taking money out of our retirement accounts will result in a penalty and often, a tax bill. We want to prioritize investing in our retirement, but it’s important to remember that’s exactly what this money is for.
Rainy day vs. investing
We want to have our full rainy day fund set up which typically is 3-6 months of living expenses before we start investing. Investing is for our medium to long-term goals. We want our money to grow, but we don’t want to have our rainy day fund or our vacation fund invested. Why?
If something were to happen and we were to need that money, we might have to pull it out of the market at a bad time (when the market is really low). We’d lose money on our investments by not waiting out the dip in the market. That’s not a powerful place to be!
Credit card debt vs. investing
We want to have our credit card debt (and any other high interest debt) paid off before we start investing. Why? When we invest, we have the opportunity to grow our money but even at the most favorable investment returns (the rate our money grows each year), it doesn’t outweigh the interest rates we’re paying on our credit cards. In addition, those investment returns are unpredictable.
Even if you’re not ready to dive in fully, you can still learn to invest now. I’m a big fan of putting aside a little bit of money to learn how to invest. You can start with as little as $25 to purchase one share of a fund or play around with an investment app. When you’re ready, you can start investing for your goals.
Student loans vs. investing
First and foremost, we always want to stay current on our monthly student loan payments, regardless of what goals we prioritize. Then, on whether to pay down our student loans or invest, it is definitely one of the “it depends” answers. Typically, it is recommended to invest (rather than pay off your debt) if your interest rates are below 6% because it’s reasonable to expect to earn more than 6% invested in the market over time (emphasis on “over time”).
Unfortunately, we can’t predict what will be happening in the market when we decide to prioritize paying down our loans. In 2019, the market returned over 25%, yet previous years have seen negative returns.
It’s also important to take into account your relationship to debt. Some people are happy to continue making monthly payments on their student loans until they’re paid off, while others are more eager to pay them off as soon as possible. It’s important to take into account these more subjective criteria as well.
Student loans vs. 401(k)
Deciding whether to invest in your 401(k) or pay down your student loans is very similar to deciding whether or not to invest or pay down your student loans. The key difference is that investing in our 401(k) comes with some additional benefits. The first to consider is a 401(k) match. If your company offers 401(k) matching, they are offering to contribute money to your retirement when you contribute. It’s free money and should be prioritized!
401(k)s also offer tax benefits. We only pay taxes once, regardless of whether we invest in a Roth or Traditional 401(k), and we may get a tax write-off in the current year for contributing. To help you weigh your options, check out this calculator.
529 vs. 401(k)
A 529 plan is a tax advantaged account to save for your child’s education. It functions a lot like an IRA for qualified education expenses such as tuition and books. It’s important to prioritize saving for our retirement before setting aside money for our children’s school as there are student loans available to them to pay for college (as well as financial aid and scholarships!) but there aren't any retirement loans other than credit cards.
If paying for school is a goal of yours, you might decide to prioritize this ahead of your general investing as these accounts receive the same tax benefits at 401(k)s. Our money grows tax free!
Here’s a typical priority list:
Some rainy day savings
401(k) match (free money!)
Credit cards (and other high interest debt)
Remainder of rainy day fund
Max out 401(k) or other retirement saving
529 savings
Investing and student loans (order depends see above)
Other things to take into account
Our other goals
Many of us have financial goals outside of the major ones listed above. We might want to buy our first home, go back to school, or travel. It’s important to balance our long-term financial goals with living in the now. The more we do in the present, the less we’ll be able to put towards our long-term goals, so we want to strike a balance that works for our lifestyles and timelines.
We want to be realistic about when we want to achieve something. For example, is it worth it to you to pay off your student loans in seven years vs. six if you’ll have to skip taking a vacation? That’s something only you will be able to answer!
How many should I prioritize at once?
When we have multiple goals, it can be hard to decide how many to prioritize. It can feel impossible to pick just one single goal, but, when we attempt to tackle too many goals at once, we spread our savings out too thin and see very little progress on each goal.
It’s important to keep our motivation in mind. If we choose to prioritize one goal, we’ll see the most progress on that chosen goal (but only that goal). If we choose multiple goals, the goals share the progress but we get to move toward multiple goals at the same time. I most often see one to three goals at a time working best for people.