You might feel like your budget is pulling you in millions of different directions. You might need to fix your car, or save for retirement, or pay off your credit card debts. You may have a new job that requires you to buy a whole new wardrobe, or you might have kids and want to help save for their college education.
Retirement Savings Comes First
Unless you are in extreme debt, there is no financial goal more important than saving for retirement. However, many Americans neglect retirement savings for two reasons – first, it seems far away, and second, they assume they can continue working until age seventy.
Unfortunately, not all retirements are voluntary. Class dismissals, age discrimination, family obligations, and health issues can force people into early retirement. “Retirement” is an ideal choice, but it can also be the result of involuntary unemployment.
If your employer offers a “matching contribution,” taking full advantage of it should be a priority in your budget. This is the only situation where you will get a guaranteed “return” on your investment – you know your employer will add to your money based on how much you invest. It may make sense to increase your matching contribution, even if you have credit card debt. Retirement should be a priority in most cases.
Paying Off High-Interest Debt
Not all debt is bad. There may be strategic reasons that lead you to choose to pay the minimum on your debt balances. For example, you may have lower interest rates compared to other debts, or it may offer tax benefits, or you may eventually be able to convert the loan into a grant.
However, if you have credit card debt, paying it off should be a priority. Even if your credit cards currently offer a 0% promotional rate, it’s only a matter of time before that rate rises to double digits. You want to pay off the debt before that happens.
Paying off credit card debt can be considered another form of “guaranteed return” because you will save yourself from paying the highest interest rates. In June 2020, the average interest rate on credit cards was over 20%. These interest charges will quickly add up and affect your ability to save anything other than debt payments.
Starting an Emergency Fund
Once you have paid off the most bothersome forms of debt, you can avoid future debt by establishing an emergency fund. This fund will help cover unexpected expenses like a large medical bill, or it can cover living expenses after an unexpected job loss.
Experts have differing opinions on how much money to keep in an emergency fund. There may be a rule that your emergency fund should be enough to cover living expenses for three months. If you have irregular income, you may want to save more. If you have large sums of money buried elsewhere, you may not need to save as much. The most important thing is to keep something allocated for your emergency fund.
Setting Aside Money for Expected and Irregular Costs
One day, your roof will leak. Your dishwasher will break down. You will need to call a plumber. Your car will need new tires and brake pads.
These are not “emergencies” or “unexpected expenses.” They are unavoidable costs. Understand that there will be needs for home and car repairs. You just don’t know when.
Set aside a fund for these potential home and car repairs. This savings should be kept separate from the emergency fund. Instead, this is a maintenance fund for expected and potential expenses that occur at random intervals.
Similarly,
Learn that one day you will need to buy another car. So start making a car payment to yourself. This will prevent you from having to finance your next car.
Evaluate Remaining Goals Individually
Once you have saved money for retirement, paid off debts, built emergency savings, and accounted for expected maintenance costs, you can start thinking about all your other financial goals. The priority of these additional goals can be determined by comparing their relative costs.
Make a list of all the remaining goals you want to save for. It could be a 10-day trip to Paris, a kitchen remodel with stainless steel and granite, or luxurious holiday gifts for your parents. At this stage, don’t stop thinking about how to pay for this. Whatever it is, add it to the list.
After you have added all your ideas, write a target date for each of these goals. Don’t worry about whether they are “realistic” – you’re still brainstorming at this point.
Calculate the Costs
Next, write the target amounts next to each goal. Your dream trip to Paris will cost $5,000. The kitchen remodel will cost $25,000. The luxurious holiday gifts will cost $800. Be as precise as possible with these numbers. The more accurate they are, the better your budget will be.
Divide
Divide the cost of each goal by its deadline. If you set the deadline in months, this will tell you how much you need to save each month to achieve your goal. If you want a $5,000 trip to Paris in one year, for example, you will need to save about $416 a month ($5,000 ÷ 12). If you want to do a $25,000 kitchen remodel over two years (24 months), you will need to save about $1,041 a month ($25,000 ÷ 24).
Simplify Your List
As you do your calculations, you may notice that you can’t achieve all your goals by your preferred deadline – especially after considering retirement savings, debt repayment, and building an emergency fund. Remember, retirement, paying off credit cards, and emergency savings should be your top financial priorities.
So since your initial ideas are unrealistic, it’s time to start scaling back those goals until they become realistic. You can eliminate some goals altogether. You might decide that you don’t need to remodel the kitchen after all. You can also push back the deadlines for some goals. A trip to Paris in one year may be realistic, but if you postpone the deadline by just six months, you can cut down more than $100 from the amount you’ll need to save each month.
Conclusion
Retirement comes first when it comes to budgeting priorities. After that, you need to tackle high-interest debt forms, such as credit card balances. From there, you can focus on building emergency savings and expected maintenance costs. Only after achieving all those goals should you consider extra expenses.
Don’t forget that managing money is a two-way street. Money comes and goes. A well-defined budget will help you avoid debt and work toward your financial goals, but you can increase your savings rate by earning more. If you don’t have a raise, seek out extra jobs you can do during the evenings and weekends. Save every dollar you earn from your side job, and use your main job’s paycheck to cover living expenses and pay off debt.
Before long, with enough discipline, you will be on your way to Paris.
Source: https://www.thebalancemoney.com/how-to-prioritize-your-budget-453693
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