A Hierarchy of Savings

When my father retired from the Navy after 27 years of service, he found a job with ARA Services.  The company (now known as Aramark) had a special initiative tied to hiring veterans.   Upon joining the firm, he was awarded a small amount of shares in the publicly traded company.  My father told me that he now owned part of the company.  As a 10-year-old, I was fascinated that my father “owned” the company.  It took many more conversations for me to fully understand what stock ownership meant. 

For a long time, I looked up the company stock price in the newspaper every day to see how wealthy we were becoming.  Unfortunately, with 5 kids in Catholic grade schools and high schools those shares were eventually sold.  It didn’t matter because I was hooked by the markets and investing.  It’s been a lifetime of study, learning, and making mistakes.  If someone tells you they haven’t made mistakes in investing, they are either lying or not investing.            

For this month’s article, I’m offering my thoughts on prioritizing your savings or in other words, a hierarchy of savings.       

1)      First and foremost, do not carry credit card balances month to month.  Many people rationalize a large purchase because they are getting cash back or airline miles.  These rewards cards are often 10 to 25 basis points higher than the national average interest rate, which currently sits at 16.91%.  If you are disciplined at paying off monthly, then by all means use a rewards card. 

Regardless, of which type of card, maintaining a balance is costly.  A $5,000 purchase on a card with 17% interest rate with a $200 monthly payment will take 2 years and 8 months to payoff.  The interest alone will add $1,216 more.  It’s a savings killer.  If you have balances on multiple cards, you should take steps to remedy it.  

One method is to focus on the highest interest balance and start making additional payments.  Or focus on the smallest balance to get the psychological satisfaction of retiring debt sooner.  There are a number of online calculators to model different outcomes or you can ask your CERTIFIED FINANCIAL PLANNER™ professional.

2)      Build an emergency fund.  Depending on your situation, having at least 3 months of expenses saved in a liquid account is critical.  For families with 1 wage earner, this should be closer to 6 months.  While today’s job market is tilted in the job seeker’s favor, not everyone has the most in-demand skills.  I’d suggest considering addition training and education in your field to continue to build your brand equity.

3)      Don’t leave money on the table.  If you work for a firm that matches your retirement savings, at the very minimum, contribute up to the match.  If you truly want to build wealth, contribute the maximum you can to any pre-tax vehicle, such as a 401(k). 

4)      If you’ve been able to complete the 3 items above, you should be in fairly good shape.  If you want to continue to improve your retirement outcomes, consider funding an IRA.  Depending on your situation this may mean a deductible Contributory IRA, a non-deductible Contributory IRA, or a ROTH IRA.  There are nuances to selecting each of these depending on income tax brackets, earned income, age, and your particular needs.  An advisor should be able to help you sort through the issues.

5)      If you have children, a 529 Plan can be a great vehicle to save for college education expenses.  To be clear, in many cases, this should be last on your list and why it’s listed last here.  It might sound a little heartless, but your retirement savings are more important.  Who do you think is going to take care of you if you have no savings?   In my mind, it’s better to not be a financial burden to your children in your retirement.  Be aware that savings into a custodial account (vs. 529) will count against your child in applying for Federal financial aid.

If you are overwhelmed by this or if you just have questions, feel free to contact me.

Bonus Book Recommendation:  If you have an interest in economics, especially how it plays out in history, I highly recommend The Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed.  I was a little pre-occupied when it was first published in 2009. 

As always, feel free to share with others and make suggestions for future articles: peter.oneill@fiduciamwealth.com