How to Prioritize Your Budget
Feeling Pulled in a Million Directions? Here's How to Prioritize
Your budget is pulling you into a million different directions: repair your car, save for retirement, pay off your credit cards, buy a new set of work-related clothes and save for your children's college education.
How can you balance these separate savings goals, all of which require different amounts of cash and have different deadlines?
Retirement Comes First
Let's be clear: there is absolutely NO goal that's more important than saving for your retirement.
Most people ignore retirement for two reasons—one, it seems far away, and two, they assume that they can just keep working into their 70s.
Unfortunately, not all retirements are voluntary. Job layoffs, age discrimination against older workers, family care obligations and health issues can force people into an early retirement. Don't think of "retirement" as a choice; think of it as something that ideally is a choice, but might be the result of forced unemployment.
If your employer offers a "matching contribution," take full advantage of it. Some employers will contribute 50 cents for each dollar, up to a maximum amount, that you contribute to a retirement fund. Other employers may even match dollar-for-dollar.
This is the only situation in which you'll earn a guaranteed "return" on your investment. Maximize your matching contribution, even if you have credit card debt. Your retirement comes first.
If your employer doesn't offer a matching contribution, or if you've already met your limit, then your next priority is ...
Pay Off Credit Card Debt
Not all debt is bad. There might be strategic reasons why you'd choose to only make the minimum payments on a low-interest, tax-subsidized mortgage or student loan.
But if you're holding credit card debt, pay it down—even if your credit cards are currently offering a "teaser" zero-percent interest rate. It's only a matter of time before that teaser rate skyrockets into the double-digits.
Paying off your credit cards gives you a guaranteed "return," which makes it a much more attractive option than investing the money elsewhere or saving to buy some other item.
Start an Emergency Fund
This tip closely relates to the one above it: avoid future credit card debt by setting up an emergency fund. This fund will help you cover unexpected expenses like a major medical bill or costs relating to a job loss.
Experts disagree about how large your emergency fund should be. Some say it should be as small as $1,000. Others say you should save 3 months of living expenses. And yet, others go as far as to recommend saving 6-12 months of living costs. The most important thing, though, is that you set aside something.
Keep Funds for Expected, Intermittent Costs
You know that someday, your roof will leak. Your dishwasher will break. You'll need to call a plumber. Your car's engine will explode. You'll need new tires. A rock will fly through your windshield.
These are not "emergencies" or "unexpected expenses." These are inevitable expenses. You know that home and auto repairs will be needed. You just don't know when.
Set aside a fund for these inevitable home and auto repairs. This is separate from your emergency fund. This is simply a maintenance fund for predictable, inevitable expenses that happen at random intervals.
Likewise, you know that you'll one day need to buy another car. So start making a car payment to yourself. This will prevent you from needing to finance your next vehicle.
Make a List of Remaining Goals
Brainstorm a list of every remaining goal you'd like to save for: a 10-day trip to Paris, a stainless-steel-and-granite kitchen remodel, and lavish holiday gifts for your parents.
At this stage, don't pause to wonder how you'll pay for this. Just brainstorm the list.
Then, write the target date for each of these goals. Don't worry about whether it's "realistic"—you're still brainstorming.
Tally the Costs
Next, write the target sums next to each goal. Your dream vacation to Paris will cost $5,000. A kitchen remodel will cost $25,000. Lavish holiday gifts will cost $800.
Divide the cost of each goal by its deadline. If you want a $5,000 trip to Paris within one year (12 months), for instance, you'll need to save $416 per month. If you want a $25,000 kitchen remodel in two years (24 months), you'll need to save $1,041 per month.
At this point, you're probably noticing that you can't meet all your goals by their intended deadline—especially after you factor for retirement, paying off debt and building an emergency fund, which are your top three priorities.
So it's time to start editing those goals. You can cut a few goals completely—perhaps you don't need a remodeled kitchen, after all. You can also change the deadline on some goals—perhaps Paris in one year is unrealistic, but Paris in 18 months ($277 per month) feels more achievable.
Remember: money management is a two-way equation. The easiest way to increase your savings rate is by earning more. Look for additional jobs that you can tackle during the evenings and weekends. Save every dime that you earn from your second jobs. Pretty soon, you'll be on a flight to Paris.