This conversation could focus on the fragile economic recovery of our economy or the personal recovery of individual budgets and debt. For those starting to benefit from this recovery or have received a lump sum of cash, my focus today will be personal budgets and debt.
There is no right answer and unfortunately many professionals as well as non-professional financial columnists will differ in opinion on getting personal budgets back on track. For me, paying off personal debt is beneficial, but there are two other objectives which need to be met rather than solely focusing on paying off debt.
The first goal is to rebuild the emergency fund. Without these funds set aside, any misstep or hard times will wipe out months of progress in reducing debt if the solution results in new charges on credit cards. Thus, minimal payments need to be made on all debt with all excess funds used to rebuild the emergency fund back up to a few thousand dollars or more if appropriate. Once this is achieved, the monthly payment to the emergency fund can now be used to pay down debt as well as fund retirement.
While some advisors may stress the focus should only be paying off debt, it is my belief the addition of deposits to retirement accounts build good habits and the values that will be needed at retirement. By continuing to add to most retirement accounts, tax savings are obtained and more importantly, the time value of money will benefit the future value of these accounts. Depending upon the type and amount of debt, this will determine the amount of the available funds used to reduce debt versus the amount deposited into retirement accounts. The priority is clearly to reduce the debt, but the benefit of adding to retirement along the way cannot be downplayed.
Time value of money is both a benefit as well as a hurdle. The greater the time until the date of the goal, the more tremendously beneficial the time value of money will be. A twenty year old saving one hundred dollars per month with an average of eight percent return may have over $527 thousand at retirement from an investment of $54 thousand. Waiting one year to start, in other words not investing the first twelve hundred dollars, can reduce the ultimate value by more than $41 thousand. Not investing the last year’s twelve hundred dollars only reduces the final value by less than three thousand dollars.
To have the same retirement value, a thirty year old has to save more than twice the amount, $230 per month. But, for a fifty year old, the monthly investment climbs significantly. They must save $1,524 per month to achieve the same retirement value. Someone at this stage of their life should be earning near their maximum level, and perhaps can meet the saving requirement more easily. But, as we all know life happens and there may be many other obligations which could make meeting this monthly saving level difficult, if not impossible. Thus, time value of money has gone from being a tremendous benefit when the goal is far into the future, but a challenge when there is less or little time until the goal date arrives.
For assistance with portfolio allocations, insurance, estate planning, or investment management contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.