One of the first and most important pieces of financial advice we give clients is to create an emergency fund worth roughly three to six months of their living expenses. Saving this amount is no small feat. Once you’ve accomplished your goal you might feel like celebrating, and for good reason.
However, before immediately increasing your monthly disposable income think about ways you can further secure your future such as:
Contributing above the minimum towards any debt payments
If you are able to make extra payments, focus on paying down any high interest debt first, such as credit card debt or student loans. Next, consider making additional payments towards your home, mortgage or car payments. Even just a small amount can add up over time.
Different debt reduction strategies work for different people. Some choose to distribute extra payments equally between all loans, while others find it more beneficial to focus on paying down one loan at a time. There’s no right or wrong answer. Use the strategy that works best for you.
Increasing retirement contributions
Are you contributing to your tax advantaged retirement accounts to receive the full the tax benefit? Try to contribute at least enough to your workplace retirement plan to receive your employer’s match, and more if possible. The 401(k) elective deferral limit is $18,000 for 2016, with a catch up contribution of $6,000 if you are 50 or older. Besides your employer’s retirement account, other options include contributing to an IRA or Roth IRA.
Note: Contributions to a Traditional IRA are tax-deductible depending on your income and whether you have access to a retirement plan at work. Contributions to a Roth IRA are not tax-deductible, but eligible distributions will be tax free. See this chart by the IRS to compare the differences of an IRA and Roth IRA and who is eligible.
Saving for a big purchase
Do your financial goals include taking a big vacation, buying a home or a car? If so, start a separate fund for each of these goals. If you already have a home, consider starting a fund for home repairs or improvements. While it can be tempting, don’t dip into your emergency savings to fund any of these goals. You’ll want to make sure you use your emergency savings for actual emergencies.
While deciding where you want to allocate your extra income, make sure to give yourself a raise as well, whether it’s a bit more money to travel, dine out or go shopping. It’s important to give yourself a reward for all of your hard work.
Even with all of these choices, you may not be sure where to begin. Whether you decide to increase savings or pay down your debt will depend on a number of factors, emotionally and financially. If your debt keeps you up at night, you should consider making extra payments to reduce your liability. If you have low interest bearing debt and want to save more for retirement, consider increasing your retirement contributions.
Legacy Next’s financial forecasting has the ability to illustrate how increased contributions or a big purchase, such as a down payment, will impact your ability to achieve your future financial goals. We don’t want your financial or investment decisions to be stressful. Get more information to see how Legacy Next can help you grow smarter.