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How To Use Your Hard-earned Money To Quickly Reach Your Goals
By Elizabeth Potts Weinstein
So you have a few dollars to save, payoff debts, or invest for the future. What do you do with the money, so you can reach your goals in the quickest and easiest way possible - and not waste time or on poor decisions?
Step One: Your Emergency Fund
You have received an inheritance of $50,000. What do you do with the money? Yes, you could buy that big screen TV and sound system, and take a major vacation - but what if you wanted to make huge progress on your goals, and not let the waste away, bit by bit?
You have $500 left after your monthly bills and other fixed expenses are paid, and you set aside for gas, food, clothing, and other necessary expenses. You could spend this on little luxuries, pay extra on your mortgage, or save for retirement. How do you make the decision?
The first priority should be setting aside in your Emergency Fund. Yes, even before you pay off your credit card debt (unless you are in default or delinquent on your bills - then first pay them enough to bring them up to date).
Regardless of how much credit card debt you have, the first step in creating a prosperous future is to change your habits. When the unexpected bill comes (and it always does), you should have in your Emergency Fund to pay that bill, to avoid racking up additional credit card debt. If you have spent every extra dollar attempting to pay off your debt & have no set aside, when something unexpected happens, you will rack up even more debt and be right back where you started.
Your Emergency Fund should contain three to six months of your actual bottom-line living expenses. Or more ... I have some clients with up to one year of cash set aside; typically, they are generally risk adverse, are self-employed, or have a fluctuating income stream. Your amount is not three to six months of your salary - it is the bills and necessarily expenses you would have if you were unable to earn income. These funds should be maintained in a cash account, typically a savings or market account. The Weinstein family Emergency Fund is in an ING Direct Orange Savings Account.
A home equity line of credit (HELOC) does not count. Yes, you could use a home equity line, or take out a loan on your house, if you were unable to earn income or had emergency expenses. But, it would just rack up your monthly expenses and debt even further. And, since interest rates have risen, even the tax deduction does not compensate for the high expense of using the HELOC.
Once you have a well-established habit of saving each month, and have your Emergency Fund set aside, we can move to the next step - prioritizing debt and your life goals.
Action Step One:
Open up a dedicated savings or market Emergency Fund account. Set aside a fixed amount of each month - whether it is $50, $500, or $5,000 - until your fund is at three to six months of your living expenses.
Step Two: Pay Off "Bad" Debt
You've set up your Emergency Fund, and created a wonderful habit of saving $50, $500, or $5000 each month. We don't want to let that habit disappear ... so where do we put your next?
Step 2 is to pay off any "bad" debt. What that means really depends upon the person, and your tolerance for debt. Some people are not particularly bothered by debt, so their only "bad" debt are those with high interest rates, or minimal tax advantages (non-mortgage and non-student loan debts).
There are two situations where I may ignore the interest rate, and recommend the client pay off the debt ASAP.
(1) Loans from family or friends. These loans, while low interest, may be eating away at the relationship, without you even knowing it. They may reduce the relationship to a formal, strained, money-based transaction, instead of a loving, friendly, supportive bond. You may know the debt is a problem, or ask other relatives to see if the debt is a problem in culture of the family - if so, pay it off quick.
(2) Debt that is keeping your up at night, or making you feel unsuccessful. Debt may be the new "American way" - but it is not right for everyone, or even most people. Monthly payments, or even the idea that you could be repossessed or foreclosed upon, may be eating you up at night. You may feel venerable, or like you have never achieved any of your goals until that debt is paid off.
If this is you, then your debts may become a high priority, even over other goals, like college funding or purchasing a new home. Whether your debt should be paid off as a high priority, depends not just upon the interest rate, but upon the mental and emotional interest rate you are burdened with each month you are making loan payments.
Action Step Two:
Take a personal inventory of your debts, and how much they are costing you in mental and emotional energy. Do they bother you? How much? If so, regardless of how low the interest rate is, paying them off should be a high priority. Start today - pay an extra $10, $100, or $1000 on the principal each month. Even better, set up automatic bill payments in your online bank account bill-pay
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