How to Prioritize Your Savings
Build an emergency fund, pay off bad debts then start investing
Congratulations: You’ve decided to start saving money.
I’ve been repeating this lesson in many of my posts — good financial management maximizes your savings and investment. It’s really heartening to see that you’ve made the decision to start saving money.
So, now what?? Where are you going to put your savings?
There are so many places where you could save and invest, but how do you start? Today’s post is about how you can prioritize your savings across three major categories.
Start by building an emergency fund
Life has a nasty habit of throwing unexpected and unwelcome challenges your way. These can range from getting laid off from your job to a medical emergency or your car breaking down. The last thing you need at that difficult time is to compound the issue with a financial crunch.
Having an emergency fund which tides you over during these difficult times is a must. According to Vanguard, “Most experts believe you should have enough money in your emergency fund to cover at least 3 to 6 months’ worth of living expenses.” From my perspective, I would actually recommend an even larger amount, up to 6–12 months of your expenses. This is based on my concern about an upcoming, severe recession. If you get laid off during recessionary times, you will need a meaningful amount of time to find a good replacement job.
Unfortunately, a very large cohort of Americans don’t have an emergency fund — a recent study by the Prudential found that “50% of all respondents have less than $500 or no emergency savings fund. Nearly 4 in 10 (39%) of both millennials and Gen Z report having no emergency savings at all.” Please don’t be one of these people!
I would keep this emergency fund in a high-interest earning Internet bank account. These accounts are liquid, which means you can access the money at any time in case you have an emergency. In addition, after so many years of zero-interest rates, these accounts today can actually also earn interest for you. In today’s world (February 2023), such accounts are paying 3%+ interest.
Next, pay off bad debts
Once you have your emergency fund, move on to paying off any non-productive, “bad” debt. As I shared in a post I made on How to Differentiate Good Debt versus Bad, debts which were incurred to support consumption are “bad” debts.
When you borrow for bad debts, you are typically spending that money for goods and services which don’t provide you any return. Once you’ve used up that purchase, you no longer have what you bought, but you are left with the debt incurred to buy that item. This debt costs you both monetarily due to the interest you have to pay as well as limits your financial flexibility because you have to service that debt and can’t use monies devoted to paying your debt for anything else.
Most people don’t consider paying off debt as “savings”. However, my view is that debt is “dissaving”. You have to pay interest costs on that debt versus savings where you earn passive income. By paying off debts, you are reducing your dissavings and are getting a guaranteed return equal to the savings in interest costs.
If you have multiple bad debts, prioritize paying them off by starting with the highest interest rate. Once that’s paid off, move to the debt with the second-highest rate and so on. At the same time that you’re paying off your debts, make the decision to follow my mother’s advice: “If you can’t afford something, don’t borrow money and buy it.”
Save and invest in a diversified mix of investments
This step is a pretty big one, so today’s post can only get you started on it. As a first step, use my posts such as How to Build a Portfolio That Balances Boring Yet Safe With Exciting but Riskier Investments to start constructing a balanced portfolio. Also, take advantage of options such as your work pensions to maximize any tax-advantaged and subsidized investments (see my post titled Make Your Pension Contributions). I will also continue to post additional articles which provide background and practical tips on savings and investments.
While saving and investments seem complicated, you will get better over time. As you build and grow your portfolio, I would heartily recommend that you take time to educate yourself on the wide ranges of savings and investments available to you. There are many resources that can be found on the Internet to help you on this education process, including my posts which I hope bring value to you.
This completes today’s post on making your pension contributions. The practical steps you can start taking from today’s post are:
- Build an emergency fund: Keep 3+ months (ideally 6–12 months) of living expenses in a liquid high-interest account to cover any of the crazy and nasty challenges that life has a habit of throwing at you
- Pay off any consumption-oriented, “bad” debt: Pay off any debt that was incurred to support non-productive spending. At the same time, make the decision to not spend on consumption-expenditures that you cannot afford
- Build a diversified mix of savings and investments: Use my posts such as How to Build a Portfolio That Balances Boring Yet Safe With Exciting but Riskier Investments to start constructing a balanced portfolio. Also, take advantage of options such as your work pensions to maximize any tax-advantaged and subsidized investments (see my post titled Make Your Pension Contributions). As you build out your portfolio, take the time to educate yourself on the wide ranges of savings and investments available to you. You will get better over time, but have to get started first
Thank you again for joining me on my journey to build financial literacy for young adults and their families. Please share any comments or questions that you have in the comments section. If you are interested in reading more of my posts, please access my author page (https://vocal.media/authors/sudhir-sahay) where you can see all the posts I’ve published. Also, if there are any topics you’re interested in my broaching in future posts, please let me know. In addition to the comments section, I can be reached at [email protected]
About the Creator
Sudhir Sahay is a Sales and Marketing executive and a father of two young men. Sudhir hopes to share his journey building basic financial literacy for his children and providing savings and investing advice to their friends and peers.
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