Where should you spend your next paycheck? On savings or investing?
So you just got your paycheck (congrats!) – what happens now!? Do you start with paying off your debt? Do you save money first? Or do you jump right into paying off your debt? Unfortunately we’re not taught much about finances in school so knowing how to approach paying off debt and saving retirement can be very daunting. But, adulting doesn’t have to be as hard as you think! With this 5 step process you’ll know exactly what to prioritize and how to take control of your finances. Related Content:
This is by far the most important step. You might have debt that’s hanging over your head and weighing you down, but you need an emergency fund first. You never know what’s going to happen with your job, your car, or your health so you need to allocate a chunk of your paycheck towards saving at least 3 months of living expenses. I would advise saving more if your job is less stable. If you’re self-employed or a contractor, aim for at least 6 months of savings. Your emergency fund only needs to cover your bare essential expenses for the month. These consist of the following:
Food
Rent / mortgage
Utilities
Car payment
Car insurance
Health insurance
Phone bill
Gas
Minimum payments on your loans and debts
Everyone’s bare essentials budget is different but those categories should give you a rough idea of what to plan for. The emergency fund isn’t meant for sinking fund items like car repairs or holidays – we will cover this later on in the article!
2. Pay Off High Interest Debt (Credit Cards)
Now that you’ve got enough of a savings cushion you can move onto the high interest debt (higher than 8% interest rate). This typically consists of paying off your credit cards which usually have interest rates of 18%. So why would you pay off your credit card debt before you start investing? This is because the average return on your investments is 7%. So you most likely would be losing more money in interest on your credit card than you would be gaining by investing in the stock market. This is why most financial gurus would advise to pay off your high interest debt first. High interest rate debt is also really difficult to get out from. The interest rates are so high that just by paying the minimum payment every month it’s hard to see any progress with your debt payoff. Two popular methods that you can use to pay off your debt are the debt snowball and debt avalanche methods. The debt avalanche method: this method focuses on paying the highest interest rate debt first. The basic premise is you take all of your current debts and organize them from lowest to highest interest rate. You then start focusing on the highest interest rate debt first while paying the minimum balance on the rest. The debt snowball method: with this method you pay off your smallest loan balance first. Again, take note of all of your current debts. Organize them from smallest to highest loan balance and then tackle the smallest one first! Don’t forget to pay the minimum balance on each of the other debts! While your “wins” might seem further away, you’ll actually be saving more money in interest with the debt avalanche method. But, some prefer the immediate gratification you get from the debt snowball method. You also don’t need to strictly only use one method. Try out both and stick to the one that works best for you. The most important thing here is that the method you choose is sustainable and providing results. I will dive deeper into these budgeting methods in future articles!
3. Save For Retirement
We’re making our way through these! You might think you’re too young to start saving for retirement but time is literally money when talking about retirement. You need to start allocating a portion of your paycheck towards retirement (401k, Roth IRA, etc). Money Under 30 illustrates this with a great example:Michael, Jennifer, and Sam all save $1,000/month over the span of 10 years. But, Michael starts from age 25-35 Jennifer does it ages 35-45 and Sam does it ages 45. By the time they reach retirement, Michael has $1,444,969 Jennifer has $734,549 and Sam only has $373,407.Source: Money Under 30They all saved the same amount of money but time was on Michael’s side. Start today!! How much should you contribute? First of all, check with your employer if they offer a match program. Many employers offer to match your contribution up to a certain percentage (usually 6%). This is literally free money!! If possible, try to contribute as much as you can so you can get the maximum employer contribution.
4. Save For Sinking Funds
Is it time to invest yet!? Guess what, in step 3 when you contributed a portion of your paycheck to your 401k, you already started investing! I know you might be eager to get further into investing or saving for a home, but we need to take a brief break and get back to saving for large expected expenses! What are sinking funds? These are funds for certain events throughout the year that you expect to have to pay for. These can be anything from traveling for a wedding, to repairing the brakes in your car. Since you want to save your emergency fund for living emergencies, it’s best to plan ahead for as many sinking funds as you can. Here’s a list of some of the most common ones:
Car repairs
Holiday gifts
Holiday travel
Halloween costumes/decor
July 4th parties
Taxes
Doctor/dentist
Property taxes
Birthday gifts
Pet vaccines
Home repairs
Clothes
Charity (especially charity events)
Travel
5. Save For A House, Start Investing In The Stock Market
We made it! Now you can finally invest and save for other goals like buying a home, etc. This investing FAQ article should help you get started! If you’re renting and looking to own, these 8 steps to home ownership will get you there!
If you found these financial tips helpful, please be sure to share them with your friends or family so they also know what to do with their paychecks!
