Laura answers a listener's question about prioritizing money for various goals like buying a home, eliminating debt, and retiring.
Laura answers a listener's question about prioritizing money for various goals like buying a home, eliminating debt, and retiring.
Money Girl is hosted by Laura Adams.
Transcript: https://money-girl.simplecast.com/episodes/should-i-use-extra-cash-for-savings-investments-or-debt/transcript
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Oliva, who says:
"I'm 27 and make $55,000 a year at my day job plus income from side hustles. I have an auto loan of about $13,000, student loans of about $11,000, and no credit card debt.
I put $50 a month into a Roth IRA and plan to contribute more when I pay off my student loans.
I also want to buy a home when my student loans get paid off. Should I use extra money to open a CD for a future home, pay off my student loans, or invest more for retirement?"
Thanks for your question, Olivia; you've got terrific money goals! Knowing how to manage your money best can be challenging, especially when you want to achieve a lot with it. This post will review five steps for prioritizing your resources wisely so you build security and reach your financial dreams.
Thanks for downloading episode 931 of the Money Girl podcast! I'm Laura Adams, an award-winning author, money speaker, on-camera spokesperson, and founder of The Money Stack, a Substack newsletter. You can subscribe for free or become a paid member with access to live educational events!
You can learn more and connect with me at LauraDAdams.com. That's also where you can email your money question, learn more about my books and courses, and sign up for The Money Stack. You can also record a brief question or comment on our voicemail line at 302-364-0308.
How do you prioritize savings, investments, and debt?
Olivia's dilemma is very relatable because most of us have limited financial resources and aggressive goals we want to reach. I'll review five steps for setting priorities to manage your money wisely.
1. Build emergency savings.
Having emergency money is critical for staying safe and not relying on debt if you hit a financial rough patch, like losing your job or business income. Olivia didn't mention having any savings, so that should be her top focus.
How much emergency savings you should have is different for everyone. If you work in an unstable industry or are the sole breadwinner for a large family, you need a bigger financial cushion than a single person with no dependents and plenty of job opportunities.
I recommend that Olivia accumulate at least one to three months of living expenses. For instance, if her essential costs are $3,000 monthly, having at least that much in savings is wise. Consider it like an insurance policy that you'd be prepared to handle a potential financial hardship.
If you have $0 savings, start with a small goal, such as saving 1% or 2% of your income annually. For instance, if Olivia earns $60,000 annually from her day job and side hustles, she might save $50 a month to have a $600 cash reserve after a year.
You could also start with a small target, like saving $500 or $1,000, and increase it each year until you have a healthy emergency fund. It's critical to keep your reserve safe, which is why you should never invest it. Instead, keep it tucked away in a high-yield,
FDIC-insured savings account so it'll be there when needed.
READ ALSO: The right amount of emergency money to keep in cash
2. Invest at least 10% of your income for retirement.
Unless you expect a big inheritance or company pension, your next top financial priority should be saving enough for a comfortable retirement. As I covered in a recent interview show, Social Security Fact vs. Fiction, the future of the Social Security program is uncertain. Plus, the average benefit payment for retired American workers is less than
$2,000 a month.
The earlier you begin investing for retirement, the better. Starting early gives you more time to contribute to a retirement account, and you can leverage the power of compounding growth. That automatically happens as your earnings earn their own earnings, allowing your retirement account balance to mushroom!
Consider this: If you invest $500 monthly over 30 years for a 7% average return, you'd have about $600,000. If you started 5 years earlier and invested that same amount for the same return over 35 years, you'd have nearly $1 million.
Simply starting to invest 5 years earlier can give you almost an additional $400,000, even though you only invested an extra $30,000 ($500 per month x 60 months).
A good rule of thumb is regularly investing at least 10% to 15% of your gross income as soon as possible. For instance, if Olivia earns $60,000 annually, she should aim to invest at least $6,000 a year or $500 a month. As I mentioned, you can easily retire with more than $1 million if you do that consistently over several decades.
If you have a retirement plan at work, such as a 401(k) or 403(b), that's the first place you should invest. For 2025, you can contribute up to $23,500 or $31,000 if you're over 50.
Workplace retirement plans are convenient because they automatically deduct contributions from your paycheck and have terrific tax benefits. Plus, many employers pay matching funds that give you a 100% return on your money no matter what happens in the financial markets!
If you don't have a job with a retirement plan, it's not a problem because you can use a traditional IRA, Roth IRA, or an account for the self-employed (if you have business income). For 2025, the IRA contribution limit is $7,000 or $8,000 if you're over 50.
Olivia is on the right track by contributing $50 a month to a Roth IRA, but boosting it would be ideal, as I mentioned. If she needs to build an emergency fund from scratch, I recommend accumulating at least $500 in an FDIC-insured, high-interest savings account.
Then, she could build her savings and retirement account simultaneously. Perhaps 5% of her income, or $250, could go to each account monthly. Or, she could save and invest any smaller amount manageable for her budget.
I recommend setting up automatic transfers from your bank account so you fund your savings and retirement first–nothing is more important.
RELATED: Am I saving enough for retirement?
3. Pay down high-interest debts.
After setting emergency savings and retirement investing in motion, your next financial priority should be tackling dangerous or high-rate debts. These could include debt in collections or payday loans, credit cards, and auto loans charging double-digit interest rates. These accounts can destroy your financial health because they drain your resources and keep you from using your money to save and invest.
But don't worry yet about paying off low-interest debts, like mortgages or student loans, ahead of schedule because they're relatively inexpensive. In addition, they come with built-in tax deductions, which makes them even less expensive on an after-tax basis.
Olivia said she has no credit card debt, which is terrific! She didn't mention the interest rates on her auto or student loans, but I recommend paying down her auto loan first because it doesn't come with a tax break and likely has a higher interest rate than her student loans.
If Olivia can boost her emergency savings and retirement contributions and still have extra money, paying off her auto loan (or whichever has a higher after-tax interest rate) ahead of schedule should be her next priority.
READ ALSO: What is the best debt payoff method?
4. Fill any insurance gaps.
In addition to having emergency savings, an essential part of preparing for financial unknowns is having the right insurance. Many people get into debt because they don't have enough of the right kinds of insurance—or they don't have any insurance.
As your career progresses and your net worth increases, you'll have more income and assets to protect from unexpected events. Without enough insurance, something catastrophic could wipe out everything you've worked hard to earn.
Ensure you have enough coverage to protect yourself and those you love from something unexpected jeopardizing your financial security and happiness. For starters, everyone should have health insurance.
Plus, if you have dependents, you likely need life insurance to protect their financial futures. If you're in relatively good health, a term life insurance policy for $500,000 might only cost a couple hundred dollars annually.
Review your auto, renters, or homeowners insurance if you own or lease a car or home. In many cases, you may need more liability coverage than the minimum required by your state or mortgage lender.
And by the way, if you rent and don't have renters insurance, you should immediately buy a policy. Renters insurance is a bargain for the protections you get; it only costs about $180 per year on average.
RELATED: Should I get a mortgage or save to pay cash for a home?
5. Consider your goals.
After you build a strong financial foundation–by addressing emergency savings, retirement contributions, high-rate debt elimination, and necessary insurance–you’re in an excellent position to save for other goals.
Maybe you're like Olivia and want to buy a home someday. Or, you might dream about paying for college, starting a business, or taking an epic vacation.
Olivia asked about using a CD to save for a home downpayment. The best place to put money for a goal depends on when you will spend it. If you want the funds to grow and won't need to touch them for at least three to five years, investing them in a taxable brokerage account is an excellent option for higher growth.
However, funds you plan to spend in less than three years should be saved in a high-yield savings or a CD, depending on which option pays more.
Bank accounts and CDs pay relatively low returns but are safe, which is critical for funds you will or may need in a few years. The money you want to spend on longer-term goals typically should be invested so you earn higher returns that can outpace inflation.
Olivia, thanks again for your question, and I hope these priorities give you some direction. While it's tempting to skip steps like creating emergency savings, without it, your finances won't be as secure as they should be.
There’s plenty of time to save for a home once you have an emergency fund. Also, it might be nice to have your student loans paid off before buying a home, but it’s not necessary. I’d rather see you put more cash in the bank and regularly invest for retirement before deciding to become a homeowner.
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That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team! Steve Riekeberg audio-engineers the show. Holly Hutchings is our director of podcasts, Morgan Christianson is our advertising operations specialist, and Nathaniel Hoopes is our marketing contractor.