What to Do When You Have Competing Goals
By Aimee Calderon, CFP
As financial advisors in Orange County, California, we often have young clients with a laundry list of goals. It can be overwhelming to try and achieve any one of the goals when the list is long. Some of the frequent goals we hear are:
- Starting an emergency fund
- Saving for a house
- Paying off school loans or other debt
- Investing for retirement
- Saving for kids’ college
One of the first steps to achieving goals is to prioritize them. We can help clients prioritize by looking at time horizons for goals and interest rates on debts. Paying off high interest rate debt should almost always rise to the top of the goal list. You may want to save for a house but you also have some high interest rate debt. In today’s interest rate market, we consider anything over 7% to be a high interest rate. Typically, savings for a house purchase are held in a conservative bank account earning less than 2%. It does not make sense to earn less than 2% on savings when you can use that same money to pay down an 8% loan. Tackle the 8% loan first, then start on the house savings.
Creating an emergency fund should also rise to the top of the list. We generally recommend that our clients have emergency funds in cash equal to 3-6 months of living expenses. Having this emergency fund will help you from using credit cards to pay for unexpected expenses and derailing your ability to save for other goals. When many Americans were furloughed or laid off due to Covid-19, 2020 has been a great example of the importance of an emergency fund.
After prioritizing goals, we help clients determine the best approach to achieving goals. For emergency funds and house savings, we typically recommend utilizing a money market account or a very short-term bond fund. We do not think it is prudent to put any money that could be needed in the next few years into the stock market. If you were to invest the savings aggressively in the stock market, you may get to your down payment goal quicker. However, you also have the risk of losing some of the money. If you want to take the risk of using the stock market for house savings, you need to be willing to delay the timeframe for buying a house to avoid selling investments in a poor market environment.
We think investing in the stock market is more appropriate in retirement plans and college accounts where the time horizon is longer. If a 401k is available to you through your employer, you will probably want to take advantage of it. Your contributions to traditional 401k plans reduce your taxable income and many employers offer a company match. Make sure to contribute enough to your 401k to take advantage of the match. You do not want to leave any free money on the table.
Roth IRA’s are another great vehicle to use for retirement savings, especially when you are young. While you do not get a tax deduction for contributions to a Roth like you do for a traditional IRA or 401k, any money contributed to a Roth IRA grows tax free. If you are 30 when you start saving to a Roth IRA, that account will grow tax free for over 30 years. Unlike a traditional IRA or 401k, you will not pay tax on withdrawals from a Roth IRA in retirement. Typically, you are in a lower tax bracket when you are young, so it can make sense to contribute to a Roth IRA. If you have a Roth option available to you on your 401k plan, you may also want to consider it versus a traditional 401k.
For college savings, we usually recommend 529 College Savings Accounts. 529 accounts allow you to save for your children’s college educational expenses in a tax-free manner. And, if one child does not use all of the funds in their account for their college education, those funds can be transferred to a different child or family member (including yourself if you decide to go back to school).
It is also important to realize that you can start working towards achieving multiple goals at the same time. As mentioned earlier, paying off high interest debt and creating an emergency fund should be a priority. After these are accomplished, allocating monthly savings to more than one goal can help you feel a sense of accomplishment. We recommend clients take a good look at their budget and lower their discretionary spending where they can. Using a budget software app to track daily spending can be eye opening and allows you to see how much you are actually spending in discretionary categories. A monthly savings goal can then be determined. That monthly amount can be split among various accounts. For example, you may determine that you can save $1,000 per month. The $1,000 could be split among the various accounts:
401k plan $500
Saving for a house $350
Extra payment for school loan $100
Saving for kids’ college $50
We highly recommend using automatic transfers every month from your bank account to the various accounts created for each goal. This ensures that you “pay yourself first”. Even if you start with small amounts, you get in the routine of saving and you can easily increase the amounts in the future.
While achieving multiple goals can be overwhelming, the important thing is to get started. We have had the pleasure of helping young clients achieve their goals by being disciplined in their spending and savings. Remember, a journey of 1,000 miles begins with the first step.