In my role as an associate professor of finance at Eastern Illinois University, I try my hardest to instill the virtues of saving early in my students. That’s because in my other role, as an investment advisor representative at Lach Financial in Louisville, I see firsthand the detrimental effects of under-saving for retirement. My students know that someone who begins saving at the age of 23 will need to sock away $6,574 per year to accumulate $2,000,000 by the age of 65, while someone who begins saving at 33 will need to save $14,902 per year to reach the $2 million mark, assuming an 8% annual return. This is why in March and April each year, my soon-to-be graduates approach me and say they are eager to begin saving for their golden years. There’s just one major obstacle: student loan debt. Oh, and they want to purchase a house soon, too.
Despite what many of the financial “experts” on television will tell you, finance is seldom a world of black-and-white, but a spectrum of everything in between. However, there are several factors that I consider when working with a client who is trying to balance life’s goals, such as paying off debt while saving for a house or for retirement. Aside from the obvious tips, such as making an air-tight budget and avoiding unnecessary big-ticket purchases like a brand-new car, here are some tips for the Class of 2016.
Start an emergency fund
When I meet with a new client, the first weakness I usually see in their financial situation is the lack of an adequate emergency fund. While I typically recommend an emergency fund equal to three months of expenses for two-income households, and six months of expenses for single earners, I think it is OK to delay fully funding your emergency stash while you pay off debt and begin saving for other major financial goals. However, I would recommend that anyone working on getting out of debt have at least the equivalent of one month of expenses stashed away for emergencies. One caveat: If the stability of your employment is uncertain, I would advise you to focus on getting that emergency fund to the 3-month or 6-month level right away.
Get the most of your match
Most 401(k) plans will match employee contributions up to a limit – for example, a 50% match up to 6% of the employee’s salary. Some will even match 100% of an employee’s contribution up to the specified limit. Unless your minimum monthly debt payments are extremely high and difficult to manage, I always recommend contributing to a 401(k) plan, but only enough to take full advantage of an employer’s match. For any additional savings, I typically recommend funding an Individual Retirement Account (IRA), since most 401(k) plans are loaded with high-expense investment options and offer little in terms of investment diversification.
Eliminate the high-interest debt ASAP
While the interest rates charged on most federal student loans are (somewhat) reasonable, rates on private student loans can sometimes be as high as the rates charged on credit cards. If you have high interest rate debt, I would typically advise you to tackle it immediately. If you have a manageable debt load and also have a 401(k) match at work, contribute to the 401(k) as well, but only up to the maximum match. If you don’t have a 401(k) match, I’d advise you to pay off high-interest debt first, before saving for retirement. Paying off a 9% private student loan gives you a guaranteed 9% return – something that is impossible to find in the investing world.
About that house…
If you have a manageable debt load and the amount of one month’s worth of expenses set aside for emergencies, and if you’ve eliminated high-interest debt while taking full advantage of your employer’s 401(k) match, only then do I advise you to consider other financial goals, such as saving for a down payment on a home or saving up to pay cash for a car.
Patrick Lach ’04
Patrick Lach, Ph.D., CFA, CFP, is the founder and owner of Louisville-based Lach Financial and an associate professor at Eastern Illinois University. He is a 2004 graduate of Bellarmine University and can be reached at email@example.com.