First of all, goals can be divided into three terms: short, medium and long. A short-term goal is one you would like to accomplish within a year; a medium-term goal is one to be completed within five years; and a long-term goal is one to be completed within 10 years or even longer.
There are three important financial goals you can work toward simultaneously. As you complete each one, you can continue to work on the goals that are left. These goals are saving for retirement (long-term), paying off your credit card (medium-term) and establishing an emergency fund (short- to medium-term).
Why have these three goals been lumped together? The rule of thumb is that 15 percent of your gross income should be used for retirement. However, if you have credit-card debt and don’t have an emergency fund, then we need to work on those first, and they should be done simultaneously.
Paying off your credit card
This is the likely the most important financial move you can make. If you’re paying 18 percent interest on your credit card, your balance would double in four years if you didn’t make any payments. Of course, making no payments is an unlikely scenario, but this example demonstrates how dramatically interest can add to your balance. In turn, it demonstrates how important it is to pay off your high-interest debts. If you don’t pay them off, they can keep you from accomplishing other goals.
Creating an emergency fund
While getting out of credit-card debt is important, so is having an emergency fund. Your emergency fund should be created while you’re paying off your credit card. The reason is that an emergency expense can cause you to incur more debt, even after you’ve paid off your credit card.
How will you know when your emergency fund is adequate? When you have the amount it would take to cover your expenses if you lost your current job and had to find another. If you think it’ll take you three months to replace your current job, then you need three months’ worth of expenses in a liquid account. Liquid means you can go to the bank right now and withdraw your funds.
Saving for retirement
Let’s face it: you want to be able to provide for yourself in retirement. Once your credit-card debt is paid off and your emergency fund is adequate, then the entire 15 percent of your gross income you’ve been directing toward those goals can go toward retirement. If your company offers a 401(k) with a match, you need to take advantage of that at all times. If you don’t contribute enough to receive the full match, you’re leaving free money on the table.
So, how do we accomplish all three of these goals at once? Take 15 percent of your gross income. If your company matches 6 percent of your gross in the 401(k), then 6 percent goes to your 401(k) account. The remaining 9 percent can then be used for paying off your credit card and establishing an emergency fund. You may parse that 9 percent any way you choose. For instance, 2 percent of your gross can go to the emergency fund and 7 percent can go to paying off your credit card. When your credit card is paid off, then the entire 9 percent goes toward your emergency fund until it reaches its required amount. At that point the entire 15 percent goes toward retirement.
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