I talked in this post about my goal to retire at 50 and how much I’ve learned from the financial independence community to get me closer to that goal. But if you don’t have one over-arching financial goal like that – or if you have too many financial goals – it’s hard to know how to prioritize your financial goals.
For that, I have a short answer and a long answer. You ready?
Use this chart*
Short answer: just use this chart*. It’s from the personal finance reddit and it’s a pretty straightforward flowchart for what your financial goals should be.
I endorse this chart in particular because it doesn’t make any judgements on what you’re spending your money on. It simply lays out the tasks to do in order to optimize your finances. Also: it has pretty colors!
But if a flowchart isn’t your speed, I have five levels to work through as you figure out how to prioritize your financial goals.
How to Prioritize Financial Goals: 5 Levels
Level 1: Figure out your budget
I feel like I’ve beaten a dead horse with this one, but I’ll say it once more: you already have a budget. What you spend your money on every month IS your budget. You just might not be aware of the exact breakdown of your budget. Or you might not like the current state of your budget. But don’t go into this thinking you need to create it from scratch, because it already exists.
I’ve already talked through how to get into the habit of budgeting here, so if you’re on this level, go read that post and then come back when you’ve been at it for a couple months.
Level 2: Get yourself an emergency fund
I’ve talked about the emergency fund here and here. What you’re going to want is 3-6 months of your living expenses sitting in a savings account somewhere, untouched.
This is the money you spend when you accidentally lock yourself out of your apartment. Or in case of a sudden flat tire. This is the money that unlocks peace of mind. Because if you lose your job or need to drop some serious cash on something out of the blue – you’re covered.
And the money really should be in a savings account – not in your checking account, not invested. By not keeping it in your checking account, you won’t accidentally dip into it in your day-to-day spending. And investing it has two downsides: (1) the stock market is volatile and you want the emergency fund to be stable; and (2) it takes several days to get money back out of the stock market. The savings account is in that Goldilocks spot where it’s removed from your spending money, but not too removed.
Also. You might want to look into a high-yield rate savings account (AKA higher interest than average). Nerdwallet does regular comparisons, so I would check in with them. With higher interest on your savings account, that cash can still grow, albeit slowly.
Level 3: Consider your debt
This is where managing your finances can get fun – because you start having options. Once you have your budget and emergency fund in place, it’s time to think about your debt. At this point, you have a choice: pay off your debt or start investing your excess funds.
If you don’t have any debt – congratulations! Move on to Level 4.
If you have debt – congratulations! You still get to increase your net worth, no matter which way you decide – pay debt or invest.
I’m going into this explanation under the assumption that you’re already paying all your minimum payments on your debt. That should be part of your budget. This is for extra payments.
Ok, what you’re going to need is the amount of your debts and the interest rates. If you have a personal balance sheet, all you’ll need to add is the interest rate for each line item. Now, the flowchart* is more nuanced in how it lays out this decision, but I’ll keep it simple here.
If your interest rate is 5% or more, you should focus on paying that debt.
If your interest rate is 5% or less, you can balance paying that debt with investing for your future.
A quick note on the stock market
I didn’t pull those numbers out of thin air, I promise. See, the stock market, on average, returns about 7%. In other words, every dollar you invest in the stock market will be worth about $1.07 in a year. Of course, that’s based off historical returns (and heaven knows we’re living in unprecedented times), but that’s how people can plan to retire on their investments. The US also generally sees about 2% inflation annually (so your dollar today will buy about $0.98 worth of goods in a year).
So if you were to invest your money, you would likely see about 7% – 2% = 5% real returns on an annual basis.
Which is why 5% is the turning point.
Example time. If you’re paying 3.5% interest rate on your debt, every extra dollar you pay today toward that debt means you DON’T pay $0.035 when that extra dollar was due. Meaning you’re getting a 3.5% return.
But if you took that same dollar and invested it, you will likely make $0.05 on it. So it will be better for your net worth to invest it.
Ok, stock market babble over.
Now. Look at your debts. Are any of them above 5%? Get going on those before moving to Level 4. But if your debts are lower than that, you get to decide: do I invest that money? Or are is my debt tolerance low enough that I want to get those debts off my back?
Level 4: Think about the long-term
Alright, now that you’ve figured out what to do about your debt, your next move is to think about long-term goals. Generally, this means retirement.
The chart* suggests contributing to any employer-provided retirement accounts up to any matching percentage (basically, do what you need to do in order to get free money!) before you tackle high-interest debt.
For retirement savings, the general rule is to max out the accounts with tax benefits (401ks, IRAs, etc) before diving into taxable savings (personal investment accounts).
Long-term goals can also include things like education costs for any future children. Start with what you hope your future will look like and work backwards from there. And I don’t have a lot of advice about balancing all the different possible long-term goals – largely because I don’t think there’s a right or wrong way to go about it. Your priorities are YOUR priorities, and you need to decide what is important.
But for what it’s worth – maybe try and max out your tax-benefitted retirement savings before you venture into other long-term goals.
Balance mid-term goals
So how do you prioritize financial goals when you want to retire someday, but have other large goals between now and then? Mid-term goals like home ownership, weddings, or even a new car can make prioritizing difficult.
Your long-term goals are, by definition, far in the future. Give yourself a pat on the back for paying attention to them now! But don’t get so focused on those goals that you don’t enjoy your life between now and then. I’d suggest making small and large savings targets for each of your long-term goals. Make sure you hit your small goals on a monthly basis. Then, if you have a mid-term goal you’re pushing hard toward, you can put the rest of your savings there!
At the end of the day, it’s up to you to figure out how to prioritize financial goals. But using this chart* or these five levels can help with the process.
*but seriously, just use the chart. Let me know if you have any questions about any of the nodes!
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