A Money Girl podcast listener named Piper says, “I’m a big fan of your podcast and want some advice before moving forward with my finances. I’m 23 years old, just started my first job, and make $60,000 with an extra $9,250 as reimbursement for traveling full-time. I have student debt and really want to get rid of it. But I also want to contribute to a Roth, save for emergencies, and buy a car. My company matches up to 6% on retirement contributions, so I was planning on contributing that much and paying off my loans at the same time. What do you think my financial plan should be?”
Thanks for your question, and congrats on landing your first job, Piper! We all have limited financial resources to manage, so knowing what to prioritize is critical for achieving your goals as quickly as possible. With the New Year right around the corner, it’s the perfect time to create or revisit your financial plan.
This article (and podcast episode) will guide you when you’re unsure what to do with your money or are trying to set the best financial New Year’s resolutions for 2023.
The first step in your financial plan is shoring up emergency savings.
While getting out of debt is always a wise financial goal, I encourage you to prioritize it in the context of your entire financial life. In some cases, aggressively paying down debt ahead of schedule is the wrong financial move. First, carefully consider how much emergency money you should have and how that stacks up with what’s actually in the bank.
A cash reserve should be your top financial priority because it keeps you from going into debt if you unexpectedly lose your job or business income or have significant unexpected expenses, like medical bills or car repairs.
How much emergency savings you need is different for everyone. For instance, if you’re the sole breadwinner for a large family, you may need a bigger financial cushion than a single person with no dependents.
A good rule of thumb is to accumulate at least 10% of your annual gross income. For instance, since Piper earns $60,000, she could aim to maintain at least $6,000 in her emergency fund.
Another way to determine your target savings is by basing it on your average monthly living expenses. For instance, add your costs and bills, such as food, housing, utilities, insurance, and transportation. Then multiply the total by a reasonable period, such as from three to six months.
For example, if your monthly living expenses are $3,000 and you want a minimum three-month reserve, you need a cash cushion of $9,000. Or double that amount for a six-month fund.
If you’re struggling to build savings, you might start with a small goal, such as setting aside 1% of your income or $500 by a specific date. Then increase your goal annually until you reach a healthy reserve balance.
Even if you can only save a small amount each month, I always say that starting small is better than not starting at all! Consider automating your goal with a recurring transfer from your checking to your savings every week or month. After a while, you might not even miss the money.
Remember that your financial well-being depends on having cash to meet living expenses in an emergency, not on paying a lender ahead of schedule. So, Piper, your homework is to determine how much emergency savings you need and set a goal to fill any gap as quickly as possible.
Note that your emergency money should never be invested because that exposes it to risk. Its purpose is safety, not growth. So, please keep it in an FDIC-insured high-interest savings account where it won’t lose value and will be sitting there when you need it.
To sum up, your first step in creating a financial plan is ensuring you have enough cash. Anytime you’re unsure about a financial decision or what to do with your money, ask yourself, “Do I have the right amount of emergency money in the bank?” If not, that should be your number one priority.
The second step in your financial plan is addressing any dangerous debts.
If you’re dealing with financial hardship and have dangerous debts, handle them next. Piper didn’t mention having any, but I know some of you may be struggling with overdue bills, debt in collections, tax liens, or debt balances with double-digit interest rates. Getting caught up or immediately addressing them is critical because they can destroy your financial health.
If you’re looking for more help, check out my course Get Out of Debt Fast–A Proven Plan to Stay Debt-Free Forever. It teaches you how to manage and eliminate any debt, including dangerous ones.
Note that you shouldn’t pay off low-interest debts, such as student loans and mortgages, ahead of schedule because they’re relatively inexpensive and come with tax deductions. Please save that step for later in your financial plan after you’ve taken care of the essentials.
The third step in creating a personal financial plan is investing for retirement.
Once you have enough emergency money or regular savings and tackle any dangerous debt, your next priority is investing for retirement.
Consider this: If you invest $500 a month for 40 years with an average 7% return, you’ll have an impressive retirement nest egg of over $1.3 million! But if you focus on paying off debt ahead of schedule and don’t start investing until a decade before retirement, you’d have to invest over $7,500 a month to have $1.3 million in the bank.
In the first scenario, where you start investing early, you end up with $1.3 million by socking away a total of $240,000 over four decades. But the second scenario, where you start late, requires you to save $900,000 over a short period to have $1.3 million for retirement.
In other words, by investing early, you achieve the same financial goal but spend $660,000 less! That’s some serious savings you don’t want to miss. Investing small amounts over a long period allows you to fully leverage the effects of compounding, where you earn interest on your accumulated growth.
So, if you take one lesson from this show, it’s that not procrastinating your investing makes the difference between scraping by or having a comfortable lifestyle down the road.
A good rule of thumb is to invest at least 10% to 15% of your gross income for retirement as soon as you begin your career and have reasonable emergency savings in the bank. Remember that investments don’t count as your cash reserve because they’re not entirely liquid and get exposed to short-term risk.
For example, if you’re like Piper and earn $60,000, make a goal to contribute at least $6,000 annually to a tax-advantaged retirement account, such as an IRA, or a retirement plan at work, such as a 401(k) or 403(b).
Piper, you mentioned getting a 6% match on your workplace retirement contributions, which is fantastic. Always contribute enough to max out an employer match. However, I recommend you bump it up and contribute at least 10% per year to your workplace Roth.
For 2023, you can contribute up to $22,500, or $30,000 if you’re over age 50, to a workplace retirement account. Anyone with earned income (even the self-employed) can contribute up to $6,500, or $7,500 if you’re over 50, to an IRA starting next year.
Those increased limits are just some retirement account changes I covered in last week’s show. So be sure to check it out if you missed the previous podcast, episode 754.
The sooner you make maxing out a retirement account a habit, the better. Starting to invest early is like getting your retirement on sale because you contribute less and still see your account value mushroom over time–brilliant!
The fourth step in your financial plan is buying the right insurance.
An essential part of taking control of your finances is having adequate insurance. Many people get into debt in the first place because they don’t have enough of the right kinds of coverage—or they don’t have any insurance at all.
Make sure you have health insurance to protect yourself and those you love from an illness or accident jeopardizing your financial security. Also, review your auto and home or renters insurance coverage. And by the way, if you rent and don’t have renters insurance, you need it. It’s a bargain for the protection you get; it only costs $185 per year on average.
And if you have family who would be financially hurt if you died, you need life insurance to protect them. If you’re in relatively good health, a term life insurance policy for $500,000 might only cost a couple of hundred dollars per year.
An often-overlooked coverage is disability insurance, which replaces a portion of your income if you get sick or injured and can’t work. You’re actually more likely to have a disability that prevents you from working than to die.
Piper, if you get these coverages through work, that’s terrific. However, if you don’t have employer-provided insurance or are self-employed, purchase these critical products on your own. It’s always a good idea to review your needs with a reputable insurance agent or a financial advisor.
The fifth step in your financial plan is setting other goals.
Once your savings, retirement, and insurance needs are on autopilot and you have money left over, it’s time to reach other financial goals. Piper mentioned wanting to buy a car and repay her student loans early.
Remember that student loans and mortgages c