You may feel like the two are mutually exclusive, but it is possible to manage both with proper budgeting and planning. If you are unsure of how to make a budget, we have a helpful article: Budgeting 101: How To Create A Budget
Commit 20 percent of your income to savings and debt repayment, it’s as simple as that. Here’s a breakdown of how you need to prioritize that 20 percent.
Priority No. 1 – start an emergency fund
Many experts recommend you try to build up several months of bare-bones living expenses. We suggest you start with an emergency fund of at least $500 — enough to cover small emergencies and repairs — and build from there. You can’t get out of debt without a way to avoid more debt every time something unexpected happens. And you’ll sleep better knowing you have a financial cushion.
Priority No. 2 – get the employer match on your 401(k)
Get the easy money first. For most people, that means tax-advantaged accounts such as a 401(k). If your employer offers a match, contribute at least enough to grab the maximum. It’s free money. Why do we make capturing an employer match a higher priority than debts? Because you won’t get another chance this big at free money, tax breaks and compound interest. Ultimately, you have a better shot at building wealth by getting in the habit of regular long-term savings. You don’t get a second chance at capturing the power of compound interest. Every $1,000 you don’t put away when you’re in your 20s could be $20,000 less you have at retirement.
Priority No. 3 – toxic debt
Once you’ve snagged a match on a 401(k), if available, go after the toxic debt in your life: high-interest credit card debt, personal and payday loans, title loans and rent-to-own payments. All carry interest rates so high that you end up repaying two or three times what you borrowed.
If either of the following situations applies to you, investigate options for debt relief, which can include bankruptcy or debt management plans.
Priority No. 4 – is, again, saving for retirement
Once you’ve knocked off any toxic debt, the next task is to get yourself on track for retirement. Aim to save 15% of your gross income; that includes your company match, if there is one. If you’re young, consider funding a Roth individual retirement account after you capture the company match. Once you hit the contribution limit on the IRA, return to your 401(k) and maximize your contribution there.
Priority No. 5 – is, again, your emergency fund
Regular contributions can help you build up three to six months’ worth of living expenses. You shouldn’t expect steady progress because emergencies happen, but at least you’ll be able to manage them.
Priority No. 6. – is debt repayment
These are payments beyond the minimum required to pay off your remaining debt.
If you’ve already paid off your most toxic debt, what’s left is probably lower-rate, often tax-deductible debt (such as your mortgage). You should tackle these only after you’ve gotten your other financial ducks in a row.
Any wiggle room you have here comes from the money available for wants or from saving on your necessities, not your emergency fund and retirement savings.
Priority No. 7 is you
Congratulations! You’re in a great position — a really great position — if you’ve built an emergency fund, paid off toxic debt and are socking away 15% toward a retirement nest egg. You’ve built a habit of saving that gives you immense financial flexibility. Don’t give up now.
If you’ve reached this happy point, consider saving for irregular expenses that aren’t emergencies, such as a new roof or your next car. Those expenses will come no matter what, and it’s better to save for them than borrow.