One of the key decisions you will have to make as you work to achieve financial freedom is how to prioritize your saving and debt-reduction efforts. I recommend that you adhere to the following priority sequence:
- Save for an emergency fund starting with at least one month’s expenses.
- If your employer matches what you save in your 401(k), save the amount necessary to get the full matching dollars.
- Each month, allocate to debt reduction 50% of the money you have available for debt reduction or savings. Allocate the other 50% to your emergency fund until you have four- to six-months’ living expenses saved. I suggest four months’ for a two-income family, six months’ if there is only one income.
- Eliminate all debt except for your home and your car.
- Maximize the tax-deferred savings allowed to you by IRS guidelines. Once you reach this point and are saving as much as you can pre-tax, throw a party and reward yourself with something very special. You’ve earned it!
- Pay off your car and start saving at least $250 a month in a car fund.
- Increase your saving to at least 15% of your pre-tax income. If you don’t own a home, accumulate the money to buy one. If you already do, accelerate your payoff and continue until you own it free and clear. Also, during times when fixed-interest rates such as CDs have fallen below 3.5%, be aware that making extra payments on your house will give you a better after-tax return on your money.
- If you have children you might want to start saving for their education, quite possibly in a Roth IRA. (Chapter eight in Money Smart, “Paying for an Education,” provides in-depth guidance on this issue.)
