Contributed by: Melissa Parkins, CFP®
If you missed it, last month I began a monthly blog series geared towards millennials, like me, with topics that are important and relevant to us. Chances are you are going to have debt at some point in your life—student loans, credit cards, new cars, or perhaps a mortgage—and let’s be honest, most of us millennials are drowning in student loan debt these days! Let’s say you finally have a steady income stream and want to start building your net worth… but have enormous student loan debt and maybe some credit cards to think about too. If you are like me, a big question on your mind is probably, “with extra money in my budget over my necessary expenses, do I pay down more debt, or invest more for the future?” The decision can be overwhelming and definitely not easy answer-- how do you decide the right mix of paying down debt and saving for the future?
Things to Consider:
- First, make sure you are able to at least make the minimum payments on your debts and cover all your other necessary monthly expenses. Then, determine how much extra cash you have each month to work with for additional loan payments and to invest for the future.
- Have an adequate emergency reserve fund established (the typical emergency fund should be 3-6 months of living expenses). If you don’t have a comfortable emergency fund, start building one with your extra monthly cash flow now.
- Take advantage of your employer’s 401(k) match, if they offer one.* If there is a 401(k) match, contribute enough to get the matching dollars. You are not only saving for the future, but it’s extra money invested for retirement too!
- Make deductible IRA contributions – who doesn’t like saving for the future while saving on taxes? If you have earned income and are not covered by a retirement plan like a 401(k) through work, you are eligible to make deductible IRA contributions up to the annual limit. If you are covered by a retirement plan at work, the deduction on IRA contributions may be limited if your income exceeds certain levels.
- Make high interest rate debt a priority. Take inventory of your debts and their corresponding interest rates and terms. It is a good idea to pay more than the minimum due on high interest rate debt so you are reducing your interest paid over the life of the loan. You can do this by increasing your monthly debit amount or by making more than one payment a month. Also, check with your lenders for discounts for enrolling in auto payments – many offer a small rate reduction when payments are set to be automatically debited each month.
- Remember that interest you pay on some debt is tax deductible, like student loan interest (if your income is below certain levels) and mortgage interest (if you are itemizing your deductions). So at least some of the interest payments you are making on your loans go towards saving on your taxes.
- Lastly, don’t forget to consider what short-term goals you have to pay for in the next 1-2 years. Are you looking to buy a home and need a down payment? Wedding to pay for? New car? Or maybe you have just been working hard and want to treat yourself to a vacation! Lay out these larger short-term goals with amounts and time frame, and see how much of your monthly extra cash should be going to fund them.
Ideas and Tools to Help
- Technology – Consider the use of budgeting apps like Mint or Level Money to keep your spending in check and your goals on track
- Social Media – Look to your Twitter feed for inspiration and helpful tips (personally, I like to follow @Money for motivation).
- Do you receive commissions, bonuses or side income above your normal pay? Instead of counting on that as typical cash flow, each time it comes in put it towards paying off high interest rate debt (I do this and I promise, the feeling is rewarding!). You can also do this with your tax refund each year.
- When you receive a pay increase at work, instead of increasing your spending level, use it to increase your savings (have you read Nick’s blog on his “One Per Year” strategy?)
- Call us! We are here not only as financial planners, but also as behavioral coaches to help you effectively achieve your goals!
Ultimately, how do you feel about debt? Your balance between paying down debt and saving for the future will depend on your personal feelings about having liabilities. It is a good idea to start saving as early as possible because of the power of compounding over the long term. But that doesn’t mean you can’t be aggressively tackling your debt as well. Create a plan that you are comfortable with, review it often to make sure you are staying on track, and make adjustments as your cash flow changes over time.
Continuing on with the topic of debt… read next month about student loans and what you can be doing to be more efficient with them. Don’t forget to look for more info on our upcoming webinar in July as we’ll be going into more details about student loans!
Melissa Parkins, CFP® is an Associate Financial Planner at Center for Financial Planning, Inc.
*Matching contributions from your employer may be subject to a vesting schedule. Please consult with your financial advisor or your retirement
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Melissa Parkins and are not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax matters. You should discuss tax matters with the appropriate professional.