How to prioritize different savings goals: Emergency savings, retirement savings and debt repayment

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Managing your money can feel like staring at an overwhelming to-do list with no idea of which task needs to be crossed off first.

Should you aim to pay off your credit cards now? Do you need to start saving for your retirement that’s set to begin in 40 years? Is the emergency savings you’ve been hearing about really that important — especially when you’re young and healthy?

The answer to each of these questions is yes. Saving for your future and repaying your past debts is not an either/or situation.

Instead, the idea is to do all of these at the same time. But how?

Start with saving

If you have to rank a top priority, it should be establishing a habit that will serve you well for your entire life: knowing how to save money. It’s crucial to automate this process as much as possible to avoid any additional thinking (and the potential for spending any of the cash). Set up a direct deposit from your paycheck into a dedicated savings account for emergencies and unplanned expenses.

The emergency fund plays a critical role in establishing a healthy personal financial ecosystem. By regularly feeding this stockpile of savings, you’ll have a bigger cushion to absorb an unplanned expense that might otherwise add to your credit card debt.

For example, if you need to make a $2,000 car repair tomorrow to make sure you can commute to work, the ability to pull from your emergency savings fund is crucial. It means you can avoid putting that $2,000 expense on a credit card with a 15 percent interest rate.

Don’t miss any retirement savings perks

As you’re saving for what you don’t want to happen, you should also be setting aside money for what you do want to see on the horizon: the freedom to enjoy your time after your working years are in the rearview mirror. If your employer offers a 401(k) or other tax-advantaged retirement plan, take advantage of this via payroll deduction, and be sure to ask about matching opportunities. Contribute as much as you can to max out this benefit because it’s something everyone should love: free money.

If you don’t have an employer-sponsored retirement plan — or if you have the ability to save even more — set up automatic transfers from your checking account to an IRA to score some tax benefits from the government for your responsible retirement planning.

Aim for the 10-15 percent rule

Between your emergency savings and your retirement stash, you should aim to contribute between 10 and 15 percent of your monthly income.

Hitting that mark will be tough until you’ve slashed your high-cost debt to zero, but here’s the simple advice to remember from day one: Don’t put off saving until you pay off your debt entirely. Any delay means you will miss out on valuable compounding growth. And if you delay once, you’re likely to delay again and again. So put something away now — every dollar counts — and regularly revisit your budget to determine if you can save even more.

Develop a game plan for beating debt

The saving strategy can be a set-it-and-forget-it routine, but tackling your debts will require more energy and attention.

There is no one-size-fits-all approach to getting out of debt, but there are two starting points to consider. Both are rooted in winter weather analogies, so think of it this way: Embrace the hard work in the cold now to put yourself on a path toward sunnier days at the beach later.

  • The avalanche method: From a purely financial perspective, you will minimize the finance charges by starting with the debt that has the highest interest rate. Dedicate as much money as possible toward it while making the minimum payment on all others until it’s paid off. Then, proceed to the next-highest interest rate. You’re working your way down the interest rate mountain from top to bottom, much like the avalanche.
  • The snowball method: Instead of focusing on the interest rate attached to it, the snowball method focuses on the balance. You’ll start by committing as much money as you can toward the smallest balance you’re carrying while making the minimum payment on your other debts. When the first balance hits zero, move on to the next-smallest balance. The amount you’re contributing toward one debt will snowball as you pay off each balance. Plus, the morale boost you can get from seeing each balance at zero can help inspire you to continue rolling that snowball.

Remember that all debts are not created equal

As you work to free yourself from debt, it’s important to recognize that some types of debt don’t need to be anywhere near the top of your priority list. If you’re paying off a 30-year mortgage with a 3 percent interest rate, there’s no rush. Sure, it might feel good to see your principal get smaller, but you also might be able to earn a higher return by investing that money. Plus, you’re getting a return on that debt by building equity in your home.

Don’t let today’s mistakes be tomorrow’s regrets

Juggling saving for multiple reasons and reducing your debts might feel daunting right now, but doing the work will put you in a position for less stress in the long term. Just ask others who have been in your shoes: Nearly 40 percent of respondents in Bankrate’s recent Financial Security Poll cited failing to save enough — either for emergencies or retirement — as their biggest financial regret.

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Written by
Greg McBride, CFA
Chief financial analyst
Greg McBride, CFA, is Senior Vice President, Chief Financial Analyst, for Bankrate.com. He leads a team responsible for researching financial products, providing analysis, and advice on personal finance to a vast consumer audience.
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Senior editorial director