Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Friday, November 20, 2015

how to prioritize

This photo of a tree growing from the walls of the Tin Hau Temple in China was taken while on a recent CFA trip to Hong Kong.  Goes to show that with enough persistence, you can reach great heights.  Now, let's tie this in to personal finance.

Everyone has the same financial goals, just in different amounts. This article shows how people rank some key financial priorities. While posed as a generational divide article, it should actually pit generations against a more objective ranking of priorities. It says that Millennials are getting their priorities wrong, but it appears that Generation X does too.

Here is my ranking of how most people should prioritize these seven goals and some reasoning behind it. While everyone's situation is unique (if you don't plan to have kids, why save for their college?) this should be a useful reference for any financial plan.

  1. Emergency Fund. Every plan starts with this. Period. Your emergency fund should be able to cover several months of expenses, a few months of minimum payments on any debt and insurance deductibles (health, home, vehicle, etc). Always have cash set aside before you start investing for other goals. I do not get paid for cash my clients hold at their banks, but I would never recommend they go without it. For those who really do not want cash, there are a few ways to reimagine the emergency fund: low cost lines of credit (credit cards or HELOCs) or this investment based emergency fund outlined by Betterment.
  2. Retirement. This is probably the most expensive decision anyone will make. Even if you are one of the lucky 18% (and dwindling!) of workers covered by a pension, you may still need additional funds to maintain the lifestyle you want. For most workers, Social Security and their own savings is all they will have. Retirement savings should start as early as possible and always be taking place in the background. This is easy if your employer offers a retirement plan, but if not, it is on your shoulders.
  3. High Interest Debt. People often wonder why this is less important than having an emergency savings. After all, paying 10-20% for old credit card debt is more expensive than the almost 0% interest you hope to earn on a cash savings account. However, if you have an emergency, more cash is more useful than less debt. I am not opposed to considering high interest debt your worst emergency if your financial situation is otherwise great.
  4. House. Everyone needs to live somewhere. This is not a super high priority, however, because of all the options available for financing the purchase. While a 20% down prime mortgage may be the best option, first time buyer programs and 3% down FHA loans ease the burden a lot. Especially right now, money is cheap and buying a house shouldn't be all that difficult. However, if you never plan on owning a home, it is perfectly acceptable to leave this one out. If you plan on renting forever, you should have plenty of money set aside for future rent payments. If you already own your house outright, your emergency saving should take emergency maintenance into account.
  5. Own Student Loans, Lower priced debt. If you have debt, keep paying on it!
  6. Future Education Expenses. College is a big expense, no doubt. It is also a hugely stressful decision with a lot of complicating factors and media attention. However, it should not be a high priority for several reasons. College costs are actually very controllable, you simply have to pick a school in your price range. If you want to go to a more expensive school, there are ways to reduce that cost through public and private scholarships and work-study programs. Taking a year off to work, or getting started at a community college can not only reduce the cost but improve chances of getting merit based scholarships. Lastly, there are always student loans. Student loans are not ideal, but with income based repayment plans, forgiveness for some public service careers and reasonable interest rates make them a tool that deserves a good look. For those who have taken care of everything else, their state's 529 plan may be a good way to get a few tax advantages while getting an early start saving for future education expenses.
  7. Future Health Care Expenses. By now, we're all supposed to have health insurance. While your plan may not be perfect, it should limit your out of pocket costs, keeping it to an amount that your emergency fund would cover in, well, an emergency. After taking care of ongoing healthcare costs, future expenses should be a pretty small consideration.

Like I said, this should be a useful reference for your financial plan. It is not tailored to your situation. How to meet these priorities and what accounts and tools to use is a whole different discussion.

What priorities do you keep the highest?