When it comes to managing our finances, Iíve got one trick for keeping it simple: The percentage.
Itís the baseline for virtually any financial decision Iím about to make.† The ìpercentageî can either be how much money Iím going to make, or it could be how much money I stand to lose. Either way, determining what this value can be a simple and effective way to prioritize your next move.
Here are 5 of the main percentages you need to know that will strategically give you the most bang for your buck.
1. Get Your Full Employer Retirement Match
I put this saving goal first†because it’s the only thing I know of that could earn you as much as a 100% automatic return on your investment!
Your employer match is when the company you work for contributes or matches some amount of what you save in your 401(k). Though that might not sound like much at first, it could add up HUGE for you over time.
Letís say your company matches dollar-for-dollar up to 5% of what you save for†retirement. If you save $200 per paycheck, thatís an automatic $200 more on top from your employer for a total of $400 saved! Effectively, you’ve just doubled your savings rate for doing nothing more than … saving! Where in the world can you find a better deal than that?
Even if youíve got debt to pay at a high rate like 20%, earning a possible 100% return on those minimum savings can still highly out-weigh paying off that debt. In fact, even if your company only matches 50 cents or 25 cents for every dollar you contribute, thatís still reason enough to make getting your full employer retirement match your top priority when it comes to saving.
Talk to your Human Resources department and find out exactly what their rules are on 401(k) employer matches. You might just find out that youíve been leaving free money on the table.
2. Paying Off High Interest Debt
Interest can be a very good thing if we are earning it. But it can equally be damaging if youíve had some challenges being responsible with credit.
If youíre stuck with high interest debt, all thatís doing is eating away at money that should be going into your pocket. That’s why paying off your debt should be your next top priority. While paying off debt is not exactly “saving more money”, it effectively accomplishes the same goal by eliminating your future payments. To put it another way, paying off a credit card balance at 20% is almost as if you just gained a 20% return on investment.
When you think of your debt in those types of terms, it becomes a lot easier to see why you should focus your efforts on trying to eliminate this debt as quickly as possible, even if it means making as many†sacrifices as necessary so that you can†find extra money†to pay down the principal. Again, using the percentages,†itís not worth it to try to save any money in a savings account earning less than 1% when youíve got debt that is charging you 20% (or whatever ridiculous interest rate). By paying down that debt, you effectively give yourself back that 20% by not having to pay for it any longer. Thatís 20% more that you can use for whatever other financial goals you might have.
3. Saving Up an Emergency Fund
We all know that accidents are going to happen. No one knows when your car will decide to stop working , your basement will flood, or you’ll have to take an unexpected trip to the doctor. To deal with these kinds of things financially, youíre going to need cash that you can easily tap in a momentís notice to handle these things right away.
Most financial professionals will tell you that your emergency fund needs to be anywhere from 3 months to 6 months worth of your household income. Some people will even say to make it 12 months worth of savings. My advice is to simply come up with†whatever you can.† Even if you can only save up $1,000, thatís still better than having nothing.
You can almost completely ignore anything you read about emergency funds being a waste of money (the argument being that money could be better used as investments in the stock market getting possible 10% returns). Think about what would happen if you didn’t have an emergency fund and you had to put an unexpected $10,000 on your credit cards? Once that debt starts accruing at 20+%, then those returns of 10% aren’t going to look so good anymore!
The bottom line: Itís better to be prepared.
4. Save for Retirement
Even though we already touched on retirement savings above with employer matches, with debt and emergency funds out of the way we can now revisit this topic.
At its core, tax-deferred retirement saving†can be one of the best ways to save your money more wisely for two main reasons: Compounding returns and avoiding taxes.
Compounding returns are when you earn money off the money you already earned. Basically as you set aside money each month, that money will grow in earnings. And then those earnings will also grow with additional earnings, and so on. Though that doesn’t seem like much in the beginning, after a number of years, your earnings will actually start to add more to your overall nest egg value than your contributions will! The more time you give it, the†the larger and larger this fortune could potentially become.
For the sake of percentages, a good number to use for comparison is 10%.† This is approximately how much the S&P 500 has returned each year on average (according to data from NYU).† All you have to do is invest in a passively managed index fund to take advantage of it.
Avoiding taxes is the other huge†benefit to using retirement savings accounts. At a tax rate of 25%, you basically lose 25 cents for every dollar you wish to invest (if you save outside your tax-deferred plan). But when you save tax-deferred, you get to keep the whole dollar. Thatís effectively a 33% gain for simply using your 401(k) or IRA and being smart about how you save!
5. Saving for College
Though we all love our kids, saving for their college should come behind all of these other priorities. Even though it also has the power to produce approximately 10% per year, unlike your debt or retirement savings, your children can always get loans or financial aid for higher education. You canít ñ unless you want to take on more unnecessary debt.
If you are fortunate enough to have enough money to make your childrenís education a financial priority, use something called a 529 plan to avoid paying taxes. Think of it as something similar to a 401(k), but intended for funding college instead.
Summary
On the surface, personal finance can seem complicated. But if you stick to the percentages and keep these priorities in mind, youíre going to be on track. Not only will you be doing yourself a favor, but you’ll also be helping to take control over your finances in one of the most effective ways.
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Personal Capital lets you see all of your accounts in one convenient place. Sign up now for free.Author bio: DJ Whiteside is the author of Save BETTER! as well as several other personal finance ebooks. He is also the blogger behind the sites My Money Design and 1,000 Ways to Save; two places where you can learn a ton about how to optimize your saving and then use it to achieve financial freedom.
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