Whether you make $50,000 or $500,000, knowing how to put your hard-earned money to good use isn’t necessarily an intuitive skill.
While your first inclination might be to throw as much money as possible toward your credit card debt, your friend may find it difficult to focus on anything other than paying down his massive student loan balance.
And for those who’ve worked hard to finally get their debt under control, prioritizing financial goals can sometimes feel even more daunting.
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What’s the right move—funneling more funds toward a down payment on your dream home, or putting more money into your nest egg?
That’s the position Megan Branford* finds herself in. The 29-year-old Los Angeles resident makes a good living as a freelance public relations professional, and she expects to make between $85,000 and $92,000 this year.
Since she recently paid off her credit cards, she’s now ready to think seriously about one of her big goals: buying a home. But she also still has a car loan to pay off, and she's neglected her retirement savings since she went freelance.
“In five years, I’d like to buy a home, and my short-term goal is to pay off my car,” Megan says. “I could pay it off now, but I don’t know if that’s a better or worse [financial move]. I'm also trying to figure out the best way to [contribute to retirement], since I don't have a 401(k) plan anymore.”
To help Megan make sense of her competing goals, we tapped Matt Shapiro, CFP®, a financial planner with LearnVest Planning Services, for his advice on what she should consider prioritizing—padding her down payment fund or plumping up that nest egg.
What Megan Says About Her Money Goals ...
“About six months ago, I decided to launch my own entertainment public relations business after working in in-house marketing and PR for about five years.
I like being my own boss, but it means my income ebbs and flows—and because I’ve stopped receiving a predictable paycheck, I haven’t been as good about saving.
For one thing, since I don’t have 401(k) contributions automatically coming out of my pay anymore, it hasn’t been as easy to save for retirement.
And as a freelancer, I like to pay off debt whenever I get a lump-sum payment from a client. I was able to pay off about $3,000 in credit card balances recently, as well as beef up my emergency fund from $3,000 to about $10,000, thanks to large chunks of income that came in.
Although I'm glad I was able to pad my emergency savings with that money, I don't know if that's enough.
I now have no debt aside from the $8,000 I have left on my auto loan, which is at a 0.9% APR. The monthly payments are only $200 a month, but I actually pay $320 to pay it off faster—and I wonder if I should be even more aggressive.
One of my biggest goals, though, is to save up to buy a house—a real challenge considering I live in one of the most expensive cities in the country. I have about $20,000 sitting in a brokerage account that I could use toward a down payment, but I don’t have any other savings earmarked for a home.
I know that I’ll need a lot more than that for a 20% down payment, because I’d like to buy a two-bedroom condo, which I think will be a good investment. Unfortunately, by the time I'm ready to buy, a two-bedroom will probably cost about $550,000 in the parts of the city where I'm looking to live.
It helps that I try to keep my costs low by renting with a roommate, and by driving a Prius, which means I don’t have to fill up on gas as often.
“I’d suggest she divvy up what’s left of her take-home pay this way: three-fourths can be divided equally between her emergency fund and retirement, and a quarter can go toward her down payment.”
So right now, after setting aside 30% of my income for taxes and covering my fixed and discretionary costs, I probably have between $2,000 and $2,500 left each month to put toward my goals.
While I'd love to start putting that money toward a home, I wonder whether I should pay off my car first, so that I’ll be totally debt-free.
There’s also the matter of retirement. I have about $50,000 saved up in my old 401(k), and I opened a Roth IRA once I went freelance—but I haven’t contributed to it at all. I’m wondering if I should try to max out my $5,500 contribution on that this year.”
What the CFP® Says About Megan’s Goals ...
“Megan is doing great and is in a good position to save a lot for the future.
What I’d prioritize first are the basics: emergency savings and retirement. Since she’s self-employed, I’d like to see her have about nine months of take-home pay in an emergency fund—right now, she’s closer to two months. I'd also like to see her start contributing to that Roth IRA.
So I’d suggest she divvy up what's left of her take-home pay this way: three-fourths can be divided equally between her emergency fund and retirement savings, and a quarter can go toward her home down payment.
So if she has $2,500 to split, she should put $937 toward her emergency savings and $937 into her Roth IRA, and the remaining $626 should go toward her house fund.
However, once her emergency fund is fully funded to nine months of take-home pay, that $937 a month can be shifted toward her down payment fund.
To hit a 20% down payment for a $550,000 home within five years, she’d need to save an average of $1,800 a month, unless she decided to use money from her brokerage account. So she may want to give herself some leeway with her timeline.
If she doesn't use all of her brokerage account money to help fund her down payment, she could consider using some of it to help fund her Roth IRA up to the $5,500 maximum contribution limit.
If she wants to contribute more to retirement after maxing out the Roth IRA, she could open a solo 401(k), a special type of 401(k) account for business owners with no other employees.
As far as paying off her car goes, I actually think that should be her lowest priority. With a 0.9% APR, she shouldn’t feel a pressing need to make larger payments. I’d suggest she take that extra $120 and put it toward her other goals, which will help her reach them that much faster.”
What Megan Thinks of the CFP’s Advice ...
“I thought Matt's insight was really helpful. It didn’t occur to me to put the extra $120 I was paying each month for my car into savings because I’d always assumed it was better to pay off any debt faster.
Another surprise? How much I should have in my rainy day fund.
I’ve always read that three months of your income is how much you should aim for. Now I know that, as a freelancer, having nine months stashed away is what I should be working toward.
It’s important to me to have enough money set aside to make sure I’m covered in case something happens.
As for buying a home, I don't think I can manage to save $1,800 a month at this stage of my life, so I'm O.K. with extending my timeline. Eventually, I'll try my best to save closer to $1,500 per month.”
*Name has been changed.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.