With summer finally upon us, it’s easy to get excited about all the summer activities that you’ve been planning for during the winter — vacations with the family, outdoor-area upgrades, backyard barbecue celebrations. However, one thing you don’t want to forget is your financial plan. You don’t want the fun and busyness of summer to cause you to lose focus on building a strong financial foundation.
While everyone’s financial goals are different, we generally recommend setting these three goals for helping achieve financial stability:
- Having three to six months of emergency savings
- Being on track for retirement
- Paying down burdensome debt
If you have yet to achieve these goals, don’t fret; this financial road map can help guide you on your journey to financial wellness.
Milestone 1: Build a foundation.
If you’re at the beginning of your financial journey, you’ll want to start with the basics. While we recommend prioritizing each goal in the order shown below, you can tackle them one at a time, save for them equally or put more money toward the one that most appeals to you.
- Prioritize $500 to one month’s worth of expenses in emergency savings. This can help you cover moderate expenses or periods of unemployment without taking on new debt. Consider keeping your emergency savings in an account separate from your everyday spending so you know what is set aside for emergencies.
- Take advantage of employer matches in a health savings account (HSA) and retirement plan. This can give you an immediate return on your contributions, in addition to a tax benefit and potential market appreciation. HSAs can help you save for retirement, and they offer tax-free withdrawals when used for qualified health care expenses.*
- Pay down high-interest, nondeductible debt. Some types of debt, such as mortgages and some student loans, allow you to deduct the interest paid from your taxable income, effectively reducing their cost. However, high-interest, nondeductible debt, such as credit card debt, is likely to cost you more in interest than you can expect to earn on your investments. You’re generally better off paying down this debt first.
Bonus tip: To make achieving these goals easier, automate as much as you can. For example, you can divert part of your paycheck into an emergency savings account or a retirement account and set up automatic payments for any debt.
Once you’ve achieved this milestone, you are ready to move on to the second milestone.
Milestone 2: Gain stability.
Now that you have the building blocks of a financial foundation, it’s time to level up your financial goals.
- Save 1½ to two months’ worth of expenses in emergency savings. Not only will this help cover larger expenses or longer periods of lost income, but it can also help you weather multiple unexpected events. Given the security this can provide, you may be tempted to prioritize this level of emergency savings over an employer 401(k) match or paying down high-interest debt. But you don’t want to get too far behind on your other longer-term goals such as saving for retirement.
- Save 10% to 15% of your gross income (including any employer match) in retirement accounts. Having passed Milestone 1, you’re already receiving your employer match, but what if you could add to that total? When it comes to retirement savings, time is your ally. Saving even small amounts can provide big benefits over time. Start with what you can and pledge a portion of any future raises toward your retirement savings. Funneling bonuses and tax refunds into your retirement accounts can also help boost your savings. For this milestone, aim to save 10% to 15% of your income for retirement. This includes any employer match.
- Check your debt-to-income (DTI) ratio. Your DTI ratio can be a predictor of your financial health. The higher the number, the higher the percentage of income being used to pay off debt. If you have a high DTI ratio, you may have trouble securing loans for a home or other big purchases, or you may be forced to accept higher interest rates on those loans. To calculate your DTI ratio, divide your monthly debt payments by your monthly gross income. If you’re paying a mortgage, try to keep your DTI ratio to 35% or less. (Without a mortgage, strive for 20% or less.) To lower your ratio, start paying down the debt with the highest after-tax interest rate.
Milestone 3: Optimize your finances.
Once you’ve achieved the goals in Milestone 2, you’re now in the home stretch of building a solid financial foundation. But just as road trips can have detours, life can be full of the unexpected. You may find yourself back at an earlier milestone for one or more goals, and that’s okay. If an unforeseen expense moves you back to an earlier milestone, you can go forward knowing you’ve navigated these roads before.
- Save three to six months’ worth of expenses in emergency savings. This can help you withstand longer periods of unemployment or multiple larger expenses without having to dip into your retirement savings or taking on new debt. It can also help provide flexibility to do the things you want to do, such as taking a sabbatical, switching careers or taking time off to care for a loved one.
- Stay on track for your retirement goal. Your vision of retirement is unique, and so is your path to get there. In this milestone, the focus is on ensuring you’re saving enough to realize your unique retirement goal. Your Edward Jones financial advisor can help you adjust as necessary.
- Think about your attitude toward debt. After completing Milestone 2, your debt should be manageable. If your balances still cause you stress, you could consider paying them down. Paying off your loans will save you in interest charges, but you may need to do so at the expense of investing in other goals.
While the road to financial stability may seem long and arduous, a little planning, along with the care and consideration of an Edward Jones financial advisor, can help make your journey as smooth and enjoyable as possible.
*Edward Jones, its employees and financial advisors cannot provide tax advice. You should consult your qualified tax advisor regarding your situation.