How to prioritize your savings: follow a few principles
Transcript of the video:
Upbeat music plays throughout.
Narrator: You've covered the necessities like rent, the light bill, and groceries, and now you've got some money left over. You know you're supposed to be saving, but where do you even start?
Understanding a few principles can help you prioritize your savings goals and figure out where to put your money.
For most people, retirement is likely to be the biggest financial goal of their lives, so you may want saving and investing for retirement to be a major focus.
The first priority is to contribute to your company's retirement plan to get any matched funds it offers.
On-screen text: Source: ©2022 Morningstar. All Rights Reserved. Hypothetical value of $10,000 invested in stocks. This example is for an investor in the 24% bracket using the 2018 tax code, and it assumes an 8% annual total return. Estimates are not guaranteed. This is for illustrative purposes only and not indicative of any investment.
Animation: Chart shows a tax-deferred account growing more over 45 years than a taxable account.
Narrator: Companies often match contributions to 401(k)s. This kind of account offers tax benefits that can allow your money to compound more quickly.
If your employer offers a match, contribute enough to get the full amount.
Don't pass up free money.
Next, if there are financial burdens that could jeopardize your retirement savings, removing them is your second priority.
Pay down high-interest, non-tax deductible debt.
High-interest debt is anything over 5%, so credit cards, personal loans, and especially payday loans.
Animation: Hypothetical chart that shows the growth of debt and retirement investments over time.
Narrator: Debt with a high interest rate is likely to grow faster than any money you invest for retirement.
Debt that doesn't reach that 5% threshold or that can be deducted from your taxes—things like most federal student loans or mortgages—can be approached a little differently.
It's important to make regular payments, but for anything beyond the minimum payments, it may be better in the long run to invest instead. That's not to say there aren't some good reasons to pay down debt, like paying off your mortgage before you retire.
On-screen text: Disclosure: Investing involves risks, including the loss of principal invested. Past performance is no guarantee of future results.
Narrator: But keep in mind, you may earn more over the long run by investing than paying off low-interest debt.
Once you've got high-interest debt under control, the third priority is to create an emergency fund.
On-screen text: Source: Bankrate – January Financial Security Index Survey
Narrator: Unfortunately, most Americans don't have enough saved to take care of a surprise $1,000 expense like an emergency room visit or car repair, let alone something more severe like losing your job.
To protect your long-term savings, you can make setting aside three to six months of expenses a top priority. To figure out how much you need, add up your essential monthly expenses, things like rent, utilities, and groceries.
It may be helpful to keep your emergency fund in a separate savings account that you can access quickly but won't be tempted to "borrow" from for day-to-day expenses. This account can act as a buffer, so you don't have to pull out the credit card or raid your retirement account when you find yourself in a jam.
Now to the fourth priority: save even more for retirement. Contribute as much as you can in tax-advantaged accounts like 401(k)s and IRAs. A commonly held rule is to save at least 15% of your income. That can sound like a huge number, but don't forget that includes any match your employer offers to your retirement savings.
It's also important that you start saving as early as possible. If you didn't start saving for retirement until later in life, you may want to bump that percentage up a little bit.
Health care in retirement is another major expense to plan for. If you're on a high-deductible health plan, you may qualify for a health savings account, which is another tax-advantaged account you might want to consider.
HSAs allow you to contribute and invest pre-tax dollars for paying out-of-pocket medical expenses now or while you're in retirement. The combination of tax benefits and potential growth from investments may make an HSA an attractive vehicle for saving for medical expenses in retirement.
On-screen text: Contribute to your company's retirement plan, pay down high-interest, non-tax deductible debt, create an emergency fund, save even more in retirement, contribute to other tax-advantaged accounts, and contribute to a taxable brokerage account.
Narrator: These four savings priorities are essential for everyone. Once you've tackled them, consider additional savings goals. The priority of these will depend on your personal situation.
For example, you may want to save for a child's education.
On-screen text: Disclosure: Investors should consider, before investing, whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available in such state's qualified tuition program.
Narrator: Consider contributing to a 529 plan, which is a type of tax-advantaged investment account specifically for educational expenses. It might seem strange that this is a lower priority than something as far off as retirement, but you've got to meet your basic needs before you can help someone else.
You could also pay down other debt, even if it's tax deductible.
If you've reached all your other goals, just keep investing.
Long-term investors should invest early and often—regardless of what's happening in the market.
Though keep in mind, investing in riskier assets like stocks may not be prudent for shorter-term goals, like a vacation or a down payment on a house.
You may not have time to recover from market downswings. So, you might also want to consider using a high interest-bearing savings account rather than investing money you'll need in the next few years.
If you're still working on the essentials, that's fine—stick to your priorities. Some important principles to remember are to focus on retirement, use tax-advantaged investment accounts, and invest for long-term rather than short-term goals.
With these principles in mind and a clear set of priorities, you're ready to tackle your financial goals.
On-screen text: [Schwab logo] Own your tomorrow®