Last night I had a friend over who needed help figuring out where to put her money now that she was actually making a little bit more. The first thing we did was set up an account on Mint.com so that we could clearly see where all of her money currently was. It turns out she had money sitting in a savings account earning extremely low interest at the bank, as well as credit card and student loan debt that were only being paid the minimum each month. This raised the question – where do you allocate your money first? What is the priority when money comes in, and then where should the remaining money go? This question could be answered many different ways, but in my opinion, THIS is where you should be putting your money:
FIRST PRIORITY: Pay off debt
Even though it is tempting to chip away at the bigger student debt first, any extra money should go towards the highest interest debt, which is usually credit card debt. My friend didn’t realize how much interest she was paying (18%), and figured as long as she was paying more than the minimum, it was ok. We took money from her savings account and paid off her credit card debt in full.
If you have more than one card, pay the highest interest first, but make sure you continue to make at least the minimum payments on the other cards to avoid fees and protect your credit score. Your student loan is likely a much lower interest rate, so this is the debt you tackle next. If you think you can pay off your debt within a year, it just may be worth looking into a 0% intro offer card to transfer your card debt onto while you work towards paying it off. Compare Cards did a list of their 10 favorite 0% offer cards.
Tip: Tempted to transfer your student loan to a 0% card? Be careful, because these sneaky credit card companies sometimes will charge a 3% transfer fee – plus if you can’t pay off the debt my the end of the 0% interest intro offer, your rate will skyrocket and you’ll end up having a good aggressive cry. Like notebook kind of cry.
SECOND PRIORITY: Emergency fund
Once your debt is paid off, and if you cleared out your savings account to pay it off (but left enough in your checking to pay your bills for the next couple month) – close that account with you bank and set up an online savings account. I have mine with ALLY paying 1% (way more than any regular bank). I set up automatic transfers at the end of every month of $200 to this account, but transfer as much as you can afford. Think of it as paying yourself, and it is in an account that I do not have easy access to. If you need the money, you put in a request, and the money is transferred to your bank’s checking account within a few days. The rule of thumb is to save three to six months of income.
THIRD PRIORITY: Retirement fund
Ok, so your debt is paid off, you have money going away every month for savings and emergency fund – but you still have a little extra to play with? Make sure you’re putting it into a retirement fund. The earlier you start, the better:
If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you’ll have around $560,000, assuming earnings grow at 8% annually. If you wait until you’re 35 to start saving and put away the same $2,000 a year, but for three decades instead, with the same 8% a year, you end up with around $245,000 — less than half the money.
If your company offers 401k matching contributions – please take it! This is free money that I promise you will regret not taking advantage of. If you don’t have the option for a 401k, make sure you ask your bank about IRA options.
FOURTH PRIORITY: CD or other kind of investment
Once my emergency fund was built up and I maxed out my retirement contribution, the remaining cash in my savings account that had been built up was put into a 4-year CD with Ally. I chose the “Raise your rate” option because it allows me to raise the interest rate twice if the economy ever recovers, and it only charges two-months of interest as an early withdraw fee, which is nothing compared to the six months that most other banks charge. CD’s are zero risk, but if you’re willing to take more of a chance with this money for potentially higher returns, then you can always seek out a financial advisor who can lead you in the right direction.
This is the path that I have followed, and it has done well for me so far. Anytime my checking account begins to accumulate money past the amount I need for a couple months of expenses, I transfer that money to my online savings account. This keeps the money out of sight, and has really been effective in helping me to understand that I don’t have that money to play with (aka buy expensive shoes with). Whatever helps you to be more conscious of living below your means will play a part in building your wealth so you can really afford a closet of Louboutins one day. *sigh*