Have you noticed your friends making “big life decisions”?
Things like buying houses, starting families, and talking about investing.
You look at your own situation, or consult your spouse, and say “Can we start making these big life moves?”
Then, you might ask these three extremely common questions:
- Can we afford to buy a house when we’re still saddled with student loans?
- Does it make more sense to pay off debt or save for retirement?
- With student debt, a potential house, and long-term savings, how am I supposed to afford anything else? Let alone start a family.
If that conversation sounds familiar, you are far from alone.
Unfortunately, there’s no silver bullet plan that works for everyone. People have different loan amounts, interest rates, income, and savings. However, there are some principles you can apply that will help you understand your situation and prioritize your next steps.
In this article, we’ll outline best practices for how to untangle your financial web, and take control of your money.
1| Look At The Big Picture
Most people give up on financial planning because they get overwhelmed with the details. They don’t know how much to save, how to invest, if they should pay more than the minimums on their loans, etc..
If you find yourself in this situation, take a step back and look at the big picture. Try to compile your whole financial situation in one place. You can write it down, make a spreadsheet, or use an online tool, but you want it to show the following things:
- All of your savings – list each account separately
- All of your debt
- Interest rates on each of your loans
- Your monthly cashflows (Income, expenses, savings, etc..)
- A timeline showing your next 5 years of major expenses or financial goals
For most people, just creating this document starts to ease their financial uncertainty.
2| Go With The Flow (Cash Flow)
Unless you’ve had a major windfall and have an abundance of cash in savings, your entire financial plan will ultimately hinge on your cash flow situation. How much are you bringing in, and how much are you spending, saving, or investing?
For people who have never thought about their finances before, this can be a difficult step, but it’s imperative if you want to get a handle on your money.
You’ll want to create a monthly cashflow statement that shows how much you bring in every month and then where that money goes.
In order to start tackling your goals, you need to know how much cash you have to work with.
3| Define Your “Big Rocks”
There’s an old adage that compares life to a glass jar. The things you choose to do with your time are broken into two categories: Big Rocks (larger, more important things) and Small Rocks (smaller, less important things). If you put the big rocks in the jar first, the small rocks are able to fill in the gaps. However, if you put the sand in first the rocks will spill out over the top of the jar.
The moral of the story is to define what’s important in your life, give that priority, and let the smaller things fall into place.
The same theory holds true when you’re planning your finances. It’s easy to spend money freely and then save whatever is left. But, in order to be truly successful, you’ll need to reverse that mindset.
Decide what things are most important to you, and determine what it will take financially to get there. Then create a monthly savings plan to hit that goal.
4| Begin With The End In Mind
Although it may seem like a long way off, you should start thinking about your retirement on the first day of your career. Many employers offer a 401(k) or another retirement plan, which is a great place to start.
You may not be able to contribute huge amounts to your retirement accounts right away, but it’s important to at least start the habit of saving for that goal. It’s easy to say that you’ll start “when you feel more comfortable”, but as life changes, that time tends to get pushed back farther and farther…
Do yourself a favor, and start now. Start small if you have to, but start now.
When it comes down to it, people are living longer and longer, and you could easily need to live for 30 years with no income if you retire at 60 or 65.
5| The 5-Year Plan
I know. It’s difficult enough deciding what you want to eat for lunch, let alone come up with a plan for the next five years.
Don’t let this step scare you. This is really just an exercise to help you plan your savings. The idea is that you most likely don’t want to invest any money that you’ll need in the next 5 years.
Also, because these are cash savings goals, they’re pretty easy to break down.
Take the amount of the goal, divided by the number of months you have to reach it, and you have just created your monthly savings goal.
Some people like to create different accounts for each major savings goal that they have. Some keep a detailed budget. Either way, stay consistent and keep track of your progress.
6| Mind The Interest
The question for most people shouldn’t be whether to contribute to retirement OR pay down student loans. It should be “how much should I contribute to each?”
Now, your first priority should be paying the minimum amount on your debt so that you minimize the accrual of interest. If you truly have no cash left over after that, you may have to revisit the cash flow portion of this article. In order to save more, you will need to either find ways to make additional income or find places to cut expenses.
After this base level of loan payment is met, the balance of retirement saving vs. loan repayment becomes a bit more tricky, but usually comes down to the interest rate on the loan.
Here’s the way we like to think about this:
Historically, the US stock market has returned close to 10% per year. Going forward, we can conservatively assume that a well-allocated investment portfolio (like your retirement savings) can return 6-8% per year over the next 10+ years.
So, if we are faced with the decision of whether or not to pay back a federal loan with a 4% interest rate, or invest in the stock market where we expect returns of 6% or more, it may be beneficial to put a higher percentage of our savings into the retirement account.
If, on the other hand, we have a private loan with a 9% interest rate, it’s almost always going to make sense to tackle that loan first before applying extra money towards retirement.
Keep in mind that this is general advice for a very common situation. However, there are situations where you would want to go a different route.
For example, if you are planning to qualify for public service loan forgiveness (PLSF), or if you’re on an income-driven repayment plan (IDR) it may not make sense to make extra payments towards your loans. In these cases, you may be able to set a higher percentage of your pay aside for retirement or your short term goals.
Also, we acknowledge that it can be difficult to follow this advice, even if it makes sense logically. Some of you may have a goal to get your loans paid off as quickly as possible and are willing to postpone other goals to make that happen. That is completely fine. This is just a resource to help you understand what’s possible, and what makes financial sense.
To sum this up, as a rule of thumb, if you’re average loan interest rate is greater than 5-6% it makes sense in most cases to put a higher percentage of your savings towards that loan. If it is under that level, it may make sense to put more money towards your retirement, even though it will take you longer to pay back the loan.
7| An Art, Not A Science
Let’s be honest. It’s easy to come up with a plan, but life happens, things change, and plans need to adjust. But don’t let that discourage you from starting.
First, look at your cash flow situation. How much money do you have coming in and how much is going out?
Next, determine your big financial goals – plan a wedding, buy a home, start a family – and determine your savings timeline.
Then start contributing SOME money to retirement. Ideally, this will be at least 10% of your salary, but don’t be discouraged if you have to start with 3%.
After this, circle back to your loan situation. Considering the interest on the loan, should you be allocating more savings to that or to your other goals?
Once retirement savings and loan payments are being made, you can start planning for your other “big rock” savings goals. This is where the “art” of financial planning comes in.
It can be a bit of a balancing act to have all of these going at once, but if you prioritize your savings in the way that we listed above, you should be just fine.
Want to learn more? Check out our free on-demand webinar, where we go more in-depth and cover real examples for using these steps to solve your financial questions.
Even if everything you just read makes complete sense, it can be a daunting task to put your financial plan into action.
Maybe you work and have a family and just don’t have the brainpower at the end of the day to come up with a financial strategy. Maybe you’ve thought about this in the past, but would prefer confirmation from a financial professional that you’re making the right choice.
Whatever your situation, InvestRx® can help.
When you book a Financial Roadmap, you’ll walk through this entire process, from beginning to end, with a trained financial advisor.
We’ll help you gather all of your necessary financial documents, create a cash flow report and goal summary, and then give you a report with detailed advice on how to reach your goals.
Have a question that we didn’t answer? Feel free to contact us at any time.
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