It can be difficult to establish a hierarchy of savings. What should come first when you are paying yourself? Three basic areas represent parts of your life that need financial attention; your retirement fund, your money set aside for emergencies, and debt repayment. The last one doesn’t sound like you are paying yourself–at first. But debt management is an important part of establishing financial freedom.
Emergency Fund: A Savings Account You Hope You Won’t Use
There is some “common” wisdom that holds all employees should strive to have three to six monts worth of earnings saved up in case of an emergency. What kind of emergency? Getting laid off, getting demoted, losing out on a promotion, car accident, sudden illness, too many others to list.
But in today’s gig economy, you might need to save more if you are a contractor, freelancer, or consultant. The harder it is to get hired in your field due to competition, lack of opportunities, etc.?
The more you might need to save. Those who have jobs that easily cross markets or corporations might not need as much of an emergency fund as those who must look longer and more intensely for an opportunity.
Saving for emergencies first is smart because it’s these exact costs–medical bills, car repair, higher insurance rates after an accident and more–that wipe out savings. An emergency fund puts a firewall on the rest of your funds, protecting you from having to drain other accounts.
Second Place: Retirement Funds
Some experts advise saving roughly 15% of your income for retirement. Don’t expect Social Security to provide enough in your retirement years, and whatever retirement pay you might be entitled to as a federal worker, veteran, city or state employee, etc. should be supplemented by retirement savings.
Your net worth will come from a combination of retirement and non-retirement savings, any retirement plan you may be invested in through your employer, stocks and bonds, CDs, etc.
Retirement accounts are tricky because guidelines (which vary depending on the 401k, IRA, or other plans you use) limit contributions in certain ways for tax reasons.
It is a good idea to talk to a retirement planning expert about the most financially smart ways to invest your funds. Why? Because your goals for retirement may dictate a specific plan. Do you want to travel the world after retiring? Or do you plan to settle into personal projects, home improvement, and hobbies?
Setting up your post-retirement cash flow depends greatly on these goals and needs. Not sure where to look for retirement fund advice? Start with trusted agencies like AARP.org, state, and local government official sites, and if you work for a large company or agency there may be a representative who can help you with certain retirement options at the corporate, state, or federal level.
Paying Down Your Personal Debt
This doesn’t sound like “paying yourself first”, but the more you do to whittle down your credit card debt, the more free cash you will have to apply toward the other two areas mentioned above. Consider your credit card payments; focus on a credit card you owe the least amount on to cut that debt down to nothing over time.
Some choose to pay more on one credit card and pay the absolute minimum on all other cards until one credit card is paid off, then move on to another card. Others try to pay above the minimum on all cards but cut corners in other areas to pay more on one card than the others.
Whether you choose to attack your credit card debt like this or not, the one thing you should NEVER do if you want to maintain strong credit? Skip payments. It may feel like the right thing to do but skipping payments never helps in the long run. Avoid doing so at all costs.
Joe Wallace specializes in personal finance, military affairs, and consumer protection topics. Since 1995, his work has appeared on Air Force Television News, The Pentagon Channel, ABC and a variety of print and online publications. He is a 13-year Air Force veteran and collects unusual vinyl records, which gives him an excuse to write the vinyl blog Turntabling.net.