J.D. wrote about the three stages of personal finance often. His definitions were:
- The first stage of personal finance involves learning the basics: understanding compound interest, reducing debt, beginning to save.
- The second stage is putting the basics into practice: choosing to live frugally, saving in earnest, and pursuing financial goals.
- The third stage — the “what next?” stage — comes after we’ve mastered the fundamentals. It’s at this point that we begin to ask “why?” Why are we continuing to save? All of our debts are paid, so what’s the point? (There certainly is a point, but what is it?)
We thought of these stages when reader Sarah wrote in with her questions. Though she does still have a car loan, she is at that second stage. Here’s where she and her husband are in their financial journey.
My husband and I have worked hard over the past five years to crawl out of $36,000 of credit card debt into a much better financial position. We’ve cut spending and increased earnings and have made amazing progress. However, I would love some input on what to do next. The only debt we currently have is about $14,000 on a car loan. The car is currently worth more than the loan. We have no credit card debt, no student loan debt, and we rent our home (no mortgage). We do not have any children and do not plan on having any. We do not plan on purchasing a home anytime soon, due to the possibility of relocating for work in the next 12 to 18 months. Our main focus was paying off the credit card, then start saving. We now have about $25,000 in cash savings, which equates to about nine months of emergency funds. Neither one of us has anything put toward retirement. Our employment situation is stable for the foreseeable future. My question is: What should we be focused on now that our saving is in a reasonable place? Should we keep adding money to savings? Should we pay off the car loan? Should we start a retirement fund?
Sarah and her husband have a nice sum in cash savings, and we’d hate to see them lose their emergency fund to pay off the car. (Not knowing the interest rate on the car loan or the time left on the loan make it hard to know whether to pay this off ASAP or pay it on schedule. According to Experian, the current average new-car loan rate is 4.36 percent.) We’d suggest a two-pronged approach: get those retirement accounts going and get out of that car payment. It seems like they could afford to prioritize contributions to retirement accounts and increase their monthly car payment to significantly reduce the length of the car loan. Would you recommend this approach? What would your next step be if you were in this position?
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I’d focus on the retirement savings. The sooner you start the more impact it has, and while the car loan would have some sort of interest on it I think the compounded interest in retirement savings would make a bigger difference. Plus, the car loan payments will reflect well on their credit rating.
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With the debt paid down their credit should be excellent. They should split their focus with the highest priority being retirement since they have none and at least some effort still being placed on paying the car loan off earlier. They do not want to make the mistake of closing all of their revolving loans (known as credit cards) because having the lines available helps them, they just don’t want to have them drawn out because that would hurt their credit. (In answer to the part about the credit)
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Pay off the debt. They’ll still have $11,000 of savings left & without debt, savings will accumulate quickly, plus they have the psychological knowledge of having no debt hanging over their heads.
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Based on the limited information I’d say pay off all the car loan. If they are not buying a house, or intending to take on any more debt, why should they need to bump up their already great credit score a couple more points? Being totally debt free is s great feeling.
Having said that, if their car loan is one of those super low rates, they might be better off keeping their savings liquid and starting to invest in retirement funds a bit sooner.
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If it were me in that fortunate position, I would first max out my retirement savings. They are not getting any younger, and the sooner they start, the more they’ll have.
I’d then concentrate on paying down the car loan. For me, I’d use the savings to pay it off; $25K – $14K = $11K, which is still at least 3 months of expenses. Unless there’s a strong possibility of needing that money in the next 2 years, I think 3 months is fine for now. They can then save and bring it back up.
If you want to go extreme: could they get by for a while without a car? If the car is worth more than the loan, another option is to sell the car and get by without one for awhile, or use a small(er) amount of the savings to buy a used one.
I hope to have dilemmas like this someday.
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They don’t appear to need $25K in their emergency fund. Pay off the car loan and they’ll still have over 3 months of an emergency fund, then two prong the emergency fund and retirement rather than the car loan and retirement.
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Retirement, for the same reason parents should fund their own retirement before their kids’ education. You can borrow for school but no one is going to lend you money to retire on. The car loan is collateralized. I might pay extra on the car, but this couple has nothing toward retirement. They need to get started.
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Yes, and it’s not too late to make contributions for year 2012! Through April 15, each could open an IRA (traditional or Roth) and fund the smaller of (a) $5,000 ($6,000 if age 50 or older) or (b) his/her taxable compensation for year 2012.
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Bingo!
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–What should we be focused on now that our saving is in a reasonable place?
Now that you actually have savings your focus should be on investing and building wealth. Spend some time trying to figure out what investment style is the right match for you. Are you devoted enough to do your own research and start buying individual stocks, or would you rather stick with the simpler index funds.
–Should we keep adding money to savings?
You should always be saving more money. And after saving it, you should be investing it.
–Should we pay off the car loan? Should we start a retirement fund?
I would work towards both goals. Keep paying off the car loan while you learn more about investing and then you can make a decision. Mathematically, what really matters is the interest rate on the car loan vs your expected investment returns. You should direct your money towards whichever one is higher.
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My vote is for retirement! I know there are people in the PF community who believe “debt is an emergency”, but I’d say saving for retirement is an emergency too given the state of the economy, potential for job loss, dismal future of social security etc. Get in early. Save while you have steady jobs. Save now because you might have lean years later — like when you buy a house. Establish the habit of saving x% of your income for retirement now so you’ll always make it a priority in your budget.
Besides, if the interest rate on the car loan is lower than what you could earn saving for retirement, you’ll come out ahead. You could also be leaving money on the table if your employers offer 401K matching.
When I was paying off my student loan, I still contributed to an RRSP — then I split the tax refund between my debt and future retirement savings. Just a thought.
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I’d pay off the car. By their calculations they’d still have about 4 months of living expenses left.
After that I’d have them fully fund their retirement accounts, and then re-build their emergency fund.
After that, I’d suggest putting extra savings into index funds.
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I agree. I believe this would be the best approach. They say they are out of debt, but that car loan is still debt and I’m with Dave Ramsey on this, any debt is bad debt. If they are not planning on buying a house, who cares what their credit score is. A person’s credit score only really matters when the person wants to borrow money. Your advise is what Dave Ramsey would advise, except maybe he would specify that the retirement accounts should be 15% of their income.
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I think this may be one of those cases where it’s more about mind than math. An emergency fund means security, and it’s hard to part with some of that! It really depends on their risk tolerance and how quickly they feel they could find another job or recover from an emergency. (I’m guessing they saved that much money for a reason?)
Then again, when something like a job loss occurs, it’s nice to not have any debt…
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We bought a car almost 3 years ago with a 0% finance rate. Silly to pay off, even though we have the money to do so. I hate debt, even this debt.
First off, I would find out if their employer has a retirement fund match. If they do, make sure you are putting in enough to get the match – which is free money. I would take the amount they were paying on credit card debt and put it toward the car payment. Keep the savings intact, and put any extra into the retirement accounts.
I would also start an after tax retirement fund like a Roth IRA, to be able to control what I am investing in 100%. Many times, the company 401k only gives you a few options.
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Who the what? They’ve saved up $25k and haven’t bothered to set up retirement accounts? First priority is to get Roth IRA and give the max contribution. They even still have time to open accounts and max out the contribution for 2012! Once the account is opened, it’s time to set up regular contributions. Then, if their employers offer retirement accounts, contribute to those ASAP. Third is paying off the car loan. The returns on an investment account are likely higher than the interest they’re paying on their car loan. It’s so important to save as early as possible for retirement because of compounding interest, and because each year that you don’t contribute to retirement is a year you can’t ever get back due to annual contribution limits. Plus, by not contributing to retirement they may be passing up “free” money in the form of employer contribution matches. To me this is a no-brainer.
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I love the idea of maxing out a Roth for 2012! What a good thought!
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exactly what i was going to say.
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Yep, if necessary take 10K out of e-fund to set up Roth IRAs for 2012. Then I’d start funding 401(k)s (if any) up to the match. I like to hedge my bets so I’d take any “extra” money and split between paying off auto loan early, retirement savings above the match, and rebuilding e-fund.
Without more details on their finances it’s hard to get more specific.
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Heh… Back when I was younger and dumber I did the opposite – I focused on saving for retirement but completely neglected any emergency savings!!! As a result I racked up credit card debt to pay for car repairs and such. Doh!
I have since corrected my errant ways
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It’s worth remembering that in a *real* emergency, you can always take out your Roth contributions.
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Relocating is expensive so don’t touch the 25k in savings.
Divide the remaining available funds in to 3 categories 1)retirement 2)downpayment and 3)extra car payments.
I cannot say how much to put in retirement because Canadian taxes and American are so different. I add enough to mine to get the pension match at my work and to maximize my tax return.
When the car is paid off then start a new car savings account and put some money in it every month.
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Paying back the debt would be a good idea
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JD mentioned the salient point in his 2009 article: the third stage is that of investing.
In life, we get income from only two sources:
(a) our work (in a job or business)
(b) our investments
If you’re like most people, you start at (a) and work your way to (b). It’s what JD did and he’s been at (b) for a while now.
Only at (b) do you obtain the freedom to pursue your dreams to the max.
However, there are still many people who are somewhat intimidated by the notion of investing. To many that word immediately bring to mind the vagaries of Wall Street and Bernie Madoff.
The reality, though, is stocks or mutual funds are not the only investments available.
They’re not even the most popular investments at all.
There are other, much safer, investments that escape the public eye precisely because they offer safety. (Media headlines are not made from security and safety.)
The key to success is to become comfortable with the notion of investing, and its concepts. Then you’ll make safe and informed investment decisions.
The good news is you can do that long before you actually are out of debt and faced with the sudden responsibility: “Oh my gosh! What do I do with this money?”
Learning about investing doesn’t require you to have money to invest. All it takes is the awareness that this is the next stage and the willingness to set aside a little time to get up to speed with investing.
So the thing to do is learn all you can, so you’re ready when that last debt payment is made, or when you receive an inheritance or windfall.
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I think the advice to take money from the emergency savings to pay off the car loan is very bad advice! Jobs are not safe and the average time to find a new one is 8 months, so leaving them with a 3-4 month cushion is irresponsible and increases the likelihood they’d go further into debt if one of them lost their job unexpectedly.
Definitely continue paying toward the car but use the extra money to invest in a Roth IRA and 401k. The average rate of return is likely much higher than interest rate on the loan (8%). If it isn’t, then split the money between retirement and extra money toward the loan, but do not pay off the loan with the money already saved. That’s too risky and you’d be trading the peace of mind of being debt free for fret over how little you have in savings.
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I agree that if the car loan isn’t at an excessive rate, paying toward retirement is a better idea.
However, 8%?! Hahahahaha. That’s a pretty old number to use. I just heard a story about this recently — and how using something more like 4% is a lot more reasonable going forward.
This week marked when most people who lost half their investments in 2008 were back to even. That’s 4+ years to get…0%.
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Don’t know where you heard that, but my well-diversified portfolio has nearly doubled since 2008. Why? primarily because I left it alone and kept contributing to it steadily. I was able to get the market “on sale” and haven’t looked back since. Oh, yeah, way better than 8%.
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Mine has since 2008 too — however, 2008 was the low point. “We” (the bigger picture) are just now back basically to where we were then.
http://www.nytimes.com/2013/03/06/business/daily-stock-market-activity.html?pagewanted=all
“Robert J. Shiller, a professor of economics at Yale, has built a model for gauging whether stocks are cheap or expensive. Right now, stock valuations are above historical averages, but well below the stratospheric highs they have reached in bubbles, he said. According to his model, stocks are signaling that they can return about 3 to 4 percent a year.”
“In the bond market, interest rates edged higher, although they remain historically low. The price of the Treasury’s 10-year note slipped 5/32, to 100 30/32, while its yield rose to 1.90 percent from 1.88 percent late Monday.”
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Or this person is going with 2% — commenters quibble, but even the quibblers are tending to come in at the the 3-6% range:
http://www.marketwatch.com/story/debunking-the-myth-of-the-8-return-2013-02-27
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Pay off the car loan! That savings doesn’t mean anything if you still have $14,000 in debt (car loan). Then build up your emergency fund (prob. not that high since your jobs are stable) and aggressively save towards retirement.
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I didn’t see ages listed but assuming they aren’t in their early 20′s, then they need to stop worrying about a right-side-up car loan and immediately get their retirement savings started. Here’s what I would do:
1. If they have 401k available, start contributing towards it.
2. Take some of the emergency funds and open IRAs for each of you and fund it max for this year.
3. Pay off the car loan.
What do you need $25k sitting there doing nothing, when you’re still relatively young*, have no house, and no kids? You, net/net, have no debt. If a true emergency hits, you can walk away from the car with cash in your pocket. You have no mouths to feed other than your own.
* and if you’re not relatively young, then you have made a serious mistake in not saving towards retirement. That needs to be priority #1.
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Definitely pay off the car loan first. With a $14,000 balance they are probably paying about 300 per month. If $25000 is exactly 9 months of income then they are bringing in 2777/month and the car payment is about 11 percent of their income. When it’s paid off they’ll still have a fully funded emergency account on the lower end and can put that full car payment towards retirement every month plus another 4 percent of their income.
One concern is the statement about not planning on buying a house soon. I’d have a talk with your husband about how soon is soon and would start to put away money for a good sized down payment. You don’t want to be unprepared for that after working so hard to pay off the credit cards.
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I like the two-pronged approach splitting all extra money in half: one half goes to the car and the other goes to retirement. I have debt currently, but I also have a retirement account. They could even use what’s in their savings to max out a Roth IRA for 2012, still have a hefty emergency fund, and then use extra funds going forward to replace the money in savings, contribute to their IRA for 2013, and pay off the car more quickly.
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I would start saving for retirement ASAP. Since you might be relocating within a year or so I wouldn’t touch the emergency savings in case you have to pay moving expenses. Even if your employer will cover the expenses, I would expect you could get hit with a few unexpected costs.
But not having retirement savings concerns me. Start by contributing to a 401(k) if your employer offers it. Not only does it make saving easier by deducting the amount from each paycheck, but many employers will match part of your savings – free money!!!! If you don’t know much about investing, start reading up about it from blogs such as this or get a book by Jane Bryant Quinn, a personal finance journalist. I find she gives very sound advice free of trendy gimmicks.
One option I like are the target retirement mutual funds. Each fund has a year in the name, pick the fund whose year is closest to your target retirement date. Over time, the fund manager will adjust the asset allocation to an appropriate mix for your age. Easy peasy. Personally I would go with Vanguard since they have good customer service and very low fees.
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If employers match 401(k) contributions, then contribute up to the match. If you still have money left over, then work on the car loan and, hopefully, put something into a Roth IRA. Since you can withdraw contributions (not interest) at any time, you could consider this part of your emergency fund and pay more toward your car loan.
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My next step would consist of 2 items that you should start at the same time: 1. Start a separate savings account and start saving so that you can buy your next car for cash. Estimate when you’ll need it and how much you think you’ll pay and add to it everytime you get paid. 2. RETIREMENT RETIREMENT RETIREMENT. Max out your company plan and open Roth IRA’s for each of you. If you can’t max them out now, increase the amount you contribute annually when you receive a pay increase. I did that for years until I was able to contribute the maximum amount and I promise that it’s painless if you do it that way.
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I’m not sure what state the couple lives in, however, $25,000 for an emergency fund here in the state of California would equate to a 3 month emergency fund and it is definately NOT enough. Kudos for paying off all credit card debt, and having an emergency fund which, in my opinion is the #1 priority in these trying times.
Jobs are not secure and eventhough this couple is young, they are not infallible to health problems due to illness or accidents! Here is my take on what this couple should do: 1) Today, open and contribute the maximum to a Roth IRA to lower your tax rate this year. 2) Today, make sure you both have term life insurance should the unthinkable happen. 3)If relocation expenses are not being paid by the company you work for, set up a separate bank savings account to fund your moving expenses and start to determine how much you need to move. If you will receive your security deposit back when you move, hold onto it so you can roll it into your next home (assuming you continue to rent). This couple is young, but believe me…time flys quickly and they will need A LOT of money to retire. I assume this young couple has a good credit rating and if they make a few extra car payments a year, the car loan will eventually be reduced. Having a car loan and making consistent, on time payments will ensure their credit rating stays high so that when/if they decide to buy a home, they can get the best loan rate possible. 4) I’d advise this young couple to create a budget and factor the above into the equation.
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Contributing to a ROTH IRA does not lower your tax rate. A traditional IRA does lower your tax rate since is acts as a deduction.
ROTH contributions are AFTER TAX deductions. That’s why your not penalized for early withdrawal of the CONTRIBUTED FUNDS. For many ROTH IRA makes a decent enough hybrid emergency funds for the reason listed above.
It’s a retirement fund with the potential for penalty free withdrawals in case of emergencies.
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How long is the car going to be worth more than the loan? With people taking out 5-6 year car loans, that balance could tip at any point. I think you should pay off the car, but if that doesn’t make you feel comfortable, you should at least accelerate the payment of the loan.
If you don’t want to pay off the car, max out a Roth for 2012 and 2013. And keep $10,000 in an emergency fund. Throw 5,000 at the loan and then accelerate going forward. I disagree with the person who thinks you should save all of it for potential job loss. It sounds like this couple is young, which means presumably they could live on less and even move to a cheaper apartment.
Plus, if you lose your job, it will make it all the more important to lower your monthly expenses. A car payment is the last thing you want when you are unemployed. Imagine if they couldn’t pay it and had the car repossessed.
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Along with all of the others view on retirement savings I would use some of the savings to put the max into an IRA in time to get the benefit for 2012 taxes.
Then, if they don’t want to change anything with the car loan I recommend getting a rider on their insurance that will pay off the whole loan rather than just what their car is worth in case something happens.
One of my friends had her brand new car stolen and had to keep paying off the loan for the uncovered amount long after the car was gone.
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Again….there are NO tax advantages to ROTH IRA CONTRIBUTIONS until you retire. And even then the tax advantages are on the GAINS, not the contributions themselves (on which you’ve already paid income taxes).
Many of you folks are confusing the ROTH IRA with the TRADITIONAL IRA.
You get to deduct the traditional IRA contributions on the current tax years (contributions can be made up to tax deadline of ~April 15).
See my comments to the previous poster and read up on IRA’s before giving advice….please.
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If it were me, I’d sell the car and pay off the loan. Then I’d buy a good used car for cash. Then I’d concentrate on the retirement savings. I think long term it would be good to buy a house once they are stable in their location. I learned a few years ago how great it is to buy used cars. Cars are built to run forever now so the risk associated with buying used is much less. We have been doing this for our last 5 cars and have never had a problem.
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So what else do you want to do with the rest of your lives besides work, consumption, retirement, and death? Between the two of you, with no kids or house, you should be able to cover the financial basics easily, and then have plenty extra to follow a passion or two.
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by increasing the car downpayment, while also putting down money for retirement savings, and general savings, would be a wise decision in my view.
More generally, the third step for me would be general savings toward experiences I`d like to have in life. Travel is one of my biggest “hobbies” and having the financial freedom to travel wherever, whenever, would definitely be the third step!
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RETIREMENT RETIREMENT RETIREMENT
Time makes such a huge difference here, and the future is so uncertain, especially if the couple is over 25 this needs to be an absolute priority. Max if you can, at minimum a healthy percentage of income in tax-advantaged accounts NOW. If indecisiveness is a problem, pick something simple like a Vanguard target date fund, and if later research changes your mind then you can change.
Once that’s handled, then target your car loan, and everything else is GRAVY. Well done.
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Why do you even have such an expensive car? Sell it any buy a nice $5,000 to $8,000 used car, then put all of the money you saved (plus most of your emergency fund) into a some sort of investment for retirement.
See: http://www.mrmoneymustache.com/2012/03/19/top-10-cars-for-smart-people/
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I think Mr. Money Moustache should sell his expensive bikes and do barefoot running and make his own mukluks for winter use. Although running when you don’t have to bumps up your caloric expenditures which makes you eat excess food beyond baseline requirements, therefore driving up your cost of living, leaving you with less money for ER – because the point of everyone’s life should be geared towards ER.
Seriously, I wish the values police would just take early retirement already. Maybe they like their car.
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JACQ,
I thought it was a very valid comment. They have no retirement…what on earth are they doing with a 14k car loan? What was the cost of the car? I’ll bet it’s new, and most people with new cars cannot afford new cars. The loan itself is nearly the sum of the two cars I’ve ever bought (I had one for nearly 10 years, and the current one for 4 and it’s still going strong).
Unless they use it for work, nobody can justify that to me. And the little “to each his own” sentiments that have been running rampant here lately, are slack, meaningless, and unhelpful. The truth is best.
Maybe they like their car, and maybe I’d like a 3 week tour of Europe on the Orient Express. What you want and what you can have are two separate things. It’s a disservice to make an excuse based on the desire to have something….especially when everything else says “not a good idea”.
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Jacq’s pithy comment might have had more value if it had anything to do with Brendan’s original point, but alas, it didn’t. Your jab at MMM and the supposed values police comes out of left field. He didn’t suggest that they get rid of the car altogether and ride bikes instead. He rather suggested that they sell it and get a cheaper car. That is a perfectly valid suggestion, considering that they have no retirement to speak of.
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Reply to Jane:
There were 3 (or 4) questions in the post:
“What should we be focused on now that our saving is in a reasonable place? Should we keep adding money to savings? Should we pay off the car loan? Should we start a retirement fund?”
One of them wasn’t “should we sell our car?” From my perspective, the $5k differential is immaterial. Yes, more material for them at 2 months of expenses, but not a really big deal.
lmoot – I don’t think this couple is in the same place as many writers on this and other blogs. But then I’m making the assumption that they’re fairly young. They appear to be following something close to – and even more towards debt and savings – of Liz Weston’s balanced money formula based on their numbers. But to people with only a hammer, everything looks like a nail. Just like my first gut feeling in looking at their numbers was that they should focus on earning more now while they’re young (because that’s often my first reaction, what most people have difficulty with and what worked for me) – but then that wasn’t one of the questions.
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5k would just about max out a ROTH for the year.
I don’t understand the “they’re not in the same place” comment. I’m also fairly young at 28, and I started saving for retirement at 23 when I got my first full-time job. I’m not a money-saving extremist by any means, that’s just a personal finance basic. You don’t have to reach a certain “level” to save for retirement and not buy brand new cars before you’ve taken care of those basics. They were old enough to get married and buy a brand new car.
I’m sorry if my comments seem harsh, but they’re certainly not off-topic just because they didn’t ask for that option. I will always call out what I deem to be excuses….it’s sad that a 14k car loan is considered the norm, and ok just because they may be young. It’s not ok. and it’s definitely not ok that so many think it’s ok.
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Holy cow. You bought your first car when you were 14 years old??? I’ve never heard of someone doing that. That’s just fascinating – was there a reason why you bought a car before you could legally drive? Was it an investment?? If so, that’s just awesome that you were that entrepreneurial at that age.
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Oh jeez Jacq,
If you want to go that route. I’ll be 29 in a few weeks. I bought my first car when I was 17 after working for the local grocery store starting at 15 (my grandmother literally drove me around town to fill out applications the day after my 15th birthday).
I paid cash for the ticket price of 7k which I saved from the nearly 2 years I’d worked (and my parents….who to this day in their late 50’s have never owned a new car….were very generous to pay for the tags and taxes, at the time about $1000 I think)
I drove the car for 8 years (the car itself was 11 when it died), and I bought my current car at 25 (it’s 10 years old now).
To be clear, I am not jumping on this couple for the choice they made because it’s one that many of my peers make (buying new cars is the status quo with younger people and people who can’t afford them more and more now it seems).
My posts came from my astonishment that you and others are really trying to question someone on a personal finance blog for advising that selling the car would be the most wise thing to do. They themselves say the car is worth more than the loan…they could only gain by selling it and buying certified used.
I wasn’t even going to comment on their choices because they didn’t mention the one glaring option I was thinking of, but seeing another poster being called out for saying what I think was the most logical and obvious thing on a financial forum doesn’t rub me the right way at all.
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If I were in their situation, I would put as much as I can to my retirement account. The tax savings on the reduction of taxable income is worth more to me than the reduction of the car loan. After maxing out the 401K, then I would tackle the car loan (assuming I’m paying normal monthly car payments anyways). What’s the point of having a car paid off and $14K less in cash. I would also calculate how many months does it take to accumulate the $14K cash back if used to pay off the car. The tax savings of contributing to a 401K can help accelerate the car payments but also keep the cash handy.
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50/50– save for retirement/pay off car! Once the car is paid off, put that same payment towards retirement…maybe even take some off the top for some fun.
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Take 10k from the emergency fund and open Roth IRAs now for 2012. Since you can access the principle it still provides a safety net in a true emergency, and still leaves you with a 5 month cash emergency fund. Start contributing to your 401k at least up to the employer match, preferably higher. Set up automatic contributions for your Roths going forward, and use any extra funds to pay down the car quicker (or sell it and buy a cheaper used car to nix the payments now). Once you own your cars outright send that money to a taxable account you can utilize for a future home purchase, cash car purchase, or early retirement.
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If in the past 5 years they have managed to pay of $36k in debt and save $25k, then they probably have income dedicated to debt and savings. They could put what was going towards paying off the credit card debt as extra on their car loan each month. And put the amount they’ve been stashing in the EF towards a retirement plan. I agree that the $25k EF should be kept just where it is. Even Dave Ramsey says to fund one while paying off debt.
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I would not touch the emergency fund since they may be relocating. However, if they are still putting money into their e-fund every month, I think they can stop doing that for now. Then use that money to open a retirement account. If their employer has a 401k with a match, maybe fund up to the match, and use any extra money to pay down the car loan.
But this is also dependent on Sarah and her husband’s ages. If they’re in their 40s, they need to start funding retirement pretty aggressively. If they’re still in their 20s, I think they’re OK contributing up to the match while they pay off the car.
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Interesting question and good suggestions have been offered. I’d love to see an article discussing the NEXT step….what do you do when you’ve reached financial independence? I just turned 59 this week, hubby has been retired for about 5 years and I can’t quite pull the trigger on quitting work. We have no debt, house paid for, he has about $32,000 a year in pension and social security income and we have about a $1,100,000 in investments and retirement accounts (not including value of house in this number). What the heck? How is it possible that I still have a scarcity mentality and fear being unemployed? To make my fear even more pathetic, I will have about $25,000 a year in pension and social security if I wait until I am 66 to start collecting. Okay, now that I put this in writing I realize I just freaking need therapy!
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Barbara, you might want to check out the early-retirement.org forum. Lots of helpful people on there, some of whom have been afraid to pull the plug too – you could especially see it in the posts circa 2008.
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Thank you for the suggestion Jacq…I am sure there are others sitting on the fence like me so I will check that out.
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Barbara, what do you want to do? It sounds like you are financially stable enough that you can do pretty much anything.
If your concerns are truly financial, maybe a meeting with a financial planner will help put some of them to rest.
My guess is that’s the easy part of your problem though.
Do you like your job? If you do, maybe you don’t want to retire yet. But maybe you want to explore reducing your hours or something.
Do you like the idea of working, but not at this job? Maybe a part-time job is in your future.
If you’re tired of working altogther, or if you want to transition to part-time employment, figure out what you want to do to fill your days. I think it is a mistake to retire only to sit at home and stare at the wall. Is there a cause you are passionate about that you want to volunteer for? Do you want to travel? Go see Europe, or set out across the US in an RV. Do your kids live in a different part of the country? Maybe you want to move closer to them. Maybe they live next door and you want to move away from them. Or maybe you want to move someplace else entirely. Maybe there is a new hobby you want to try, or a class you want to take.
Who will you talk to and hang out with, if not your co-workers? (“Just my husband” isn’t a good answer. I’m sure he’s lovely, but you need more people than just him.)
Once you figure out what you could/would do instead of going to work every day, I think “pulling the trigger” will be a bit easier.
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Kate,
All good things to think about and you are correct that the financial fears are probably the easiest thing to resolve. I DO actually like working as I am a registered nurse and get a lot of warm fuzzies from that but I am currently in a stressful managerial role. The option of quitting full time work and working part time doing direct care is likely a good option for me. It would let me still care for folks and bring in a bit of cash too.
Hubby has MANY hobbies and does a lot of volunteer work so he is a good role model if I start the transition into retirement. I blame my hectic work schedule now for not getting involved in more hobbies and volunteer work but that can change if I am only working part time.
Thank you for taking the time to provide me with so many useful options!
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My first goal would be getting the emergency fund to a year’s worth of expenses while rounding the car payment up to the nearest hundred at the same time (extra toward principal, though). Then, reassess–do you have enough over/feel comfortable paying off the car loan at that point (it should be a lower loan balance at that point while the emergency fund will be higher)? Did you need to use the emergency fund for moving expenses? I guess my natural tendency is to stick with what’s working for at least 6 mos. to 1 year longer than many people assume you should, because I just want to be sure of my financial footing. More savings will never really be a bad idea.
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Step 1: Open up an IRA (either Roth or traditional) for each of you, take $10k out of your emergency fund, and fully fund it for 2012, which you can do until April 15th. A target retirement fund is a good, simple option.
With two wage-earners in the family, you should be able to get by with a slightly smaller emergency fund – odds are you won’t both be out of work at the same time for an extended period of time.
Step 2: Enroll in your employer’s 401k, if available, and contribute at least enough to get the full company match if they offer one. Don’t just stop there though – run the numbers and see if you can round up a bit more. You may find that the difference between contributing 6% and 10% only decreases your paycheck by $50-100. If you can swing a few more percentage points, do.
Step 3: Stop (at least temporarily) contributing additional income to your emergency fund. It sounds like you are stable enough that it can hang out around with $15k in the bank for a while.
Step 4: Take that money that you just stopped contributing to your emergency fund and divide it between paying off your car loan and maxing out your 2013 IRA contribution.
Step 5: Plan to drive that car into the ground.
Step 6: Continue to max out your IRA, max out your 401k, save additional money in different investment vehicles. Your whole “emergency fund” doesn’t have to be sitting in a savings account, as long as there is a decent chunk of easily accessible money in a savings account. Set up a high-yeild money market account, a bond ladder, something like that. You can get to that money in a few days if needed, but it will earn a better rate of return in something other than a plain savings account. At this point too, your goals may have changed – you may be ready to buy a house or have kids, or whatver, so you can structure your savings goals accordingly.
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My advice:
1. Pay off the car loan.
2. Put the remaining $11K into a separate emergency fund account that is hard to touch. They state, “We now have about $25,000 in cash savings, which equates to about nine months of emergency funds.” To me, the EF has to be put aside and identified as such, it’s not the same as regular savings.
3. Set up retirement accounts ASAP. They don’t say if they can contribute at work; I hope they can. If so, they should contribute the max. Without the car payment it won’t be such a sting to have the smaller paychecks. If they can’t contribute via work, they should divert the old car payment and whatever extra they can afford to an IRA.
4. Set up a “future” savings account which will fund the next car, or a down payment. They say they don’t want to buy in the near future, but saving a down payment can take years.
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The first step in financial planning should always be to determine your goals in life. Maybe you want to retire early (or late). You want to buy a home (or rent). A vacation home with a boat (or travel). You want new cars every three years (or drive’em till their dead). Without a plan you have no way to know how to structure your financial life.
That’s not to say that you neglect the basics like an emergency fund, life insurance, an estate plan, a will, etc, etc, etc. However by understanding your goals, you will be able to develop a road map to get you there. More importantly you will be able to see that you will not likely be able to do everything. Your income may not allow you to buy a travel trailer, a vacation home and spend Chirstmas skiing in the Alps. Life is about choices. Determining what your goals (choices) are and prioritizing your goals is the first step toward a financial plan. After all, saving money is not the goal. Saving money to help you achieve a goal is what you really are looking to do.
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If i were in your position, had relatively sane finances and a spouse, what i’d do is seriously reconsider my foolish decision of not having any children. That is what i’d do. Not the right thing for everyone.
On the finances i think you’ll be just fine. Anyone who has paid off that much cc-debt knows what they are doing. Keep saving, keep budjeting.
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Why is the decision not to have children foolish?
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rapid population decline is bad for the economy, less spending and future retirees/workers ratio will be unsustainable.
or on a more human note, you might regret not living a full life once you are too old to do anything about it. reproducing is the only way to really feel immortal and who doesn’t want that?
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:EYEROLL:
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Gee, I can imagine something right away that’s worse than not having kids and regretting it: Having kids and regretting it.
Childless people DO serve a purpose in society. They often have more time and resources to help out friends, family and community than those with children. (not hating on those with kids. It’s just a given that your own offspring will be first priority, as they should be.)
We all will live to regret choices we have made in our lives but the highly personal decision to have or not have children is not something to be discussed on a personal finance blog.
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Have you ever listened to Dave Ramsey?? One of my favorite Dave Ramsey sayings is “You wouldn’t take diet advic from a fat person so don’t take financial advice from a broke person” (I hope I didn’t mess that quote too much). Please be careful who you take financial advice from. Most importantly do some reading on your own. Not one author or book, but rther a collection of different viewpoints so that you can begin to formulate your own ideas and plan for your life and money
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some of my favorite reads:
The Millionaire Next Door
The Wealthy Barber
Die Broke
Stop buying Mutual Funds
Moneysense Magazine (Canadian)
Couch Potato Investing (google it)
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With the limited info provided, there will be ifs and buts in my response. No ages, incomes or interest rate for car loan stated. The facts as I see them which I’ll support thru response to how they should conduct the payoff of loan and starting a “retirement’ investing program are as follows:
Car loan S14,000, no intrest rate specified, no length of time and no payment particulars. Every loan has an early payoff premium in it so, I would recommend that they keep paying the car note instead of a payoff. As long as interest rate is fixed, pay the loan off with cheaper and cheaper dollars due to inflation. Take $5,000 of their savings and open up a self directed IRA in metals, specifically silver, As its poised to go much higher and percentage gain is better. Make it a Roth verison. Take possesion of the metal.
It appears that they can open up programed retirement savings (401k if offered by employer) meet the matching contributions plus 3%. If they are over 50, the investment should be tax differed. They would need the maximum amout of money they can because of the shorter time frame for compounding.
I would mve the saving to an account that is paying more than inflation. (currently 3.95% Official Rate)
After thie is taken care of, fund a Housing/educational account for purchasing a house/ condo and funds for the “little surprize”if that happens. Keep putting funds in the savings account and use it as a holding account used for other investments. After taht “Have Fun”
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There are a lot of factors we would to know.
If their work offers 401K matching, I would say start investing as much as they could (up until the max matching), and live off some of the money they have saved until they have enough left for a nice emergency fund.
However, if there is no 401K match, I would still say start a retirement fund, but not to overdue it. I would pay off the car first, since it has interest on it.
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If the car is indeed worth more than the loan balance, I’d sell the car, pay off the loan, and use the difference plus any savings (if needed) to buy a fuel efficient, highly rated used car for say $8,000ish? Then dedicate the former car payment to savings to quickly replenish and build more.
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I would pay off the car loan in a heartbeat. The emergency fund can be replaced and paying interest when you don’t need to is silly.
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Apparently my comment was eaten.
If you are moving soon, I would not use the emergency fund to pay off the car. However, I think at this point, you don’t need to keep putting money INTO the emergency fund.
If your job offers a 401(k) with an employer match, I would at least start funding retirement accounts up to that point, and maybe use any extra to pay down the car loan.
But this also depends on your age. If you’re in your 20s, that could work. But if you’re in your 40s, I think you should start contributing well more than that to retirement ASAP.
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Do you really need a $14k + car?
I’d sell the car, pay off the loan, purchase a quality used fuel efficent car with cash, and use some of your savings to kick start your retirement investments.
If your jobs are stable and you have no debt, then a slightly lower emergecy fund (in the short term) should be plenty sufficient.
That said, congratulations on paying off your CC debt!
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Take 10k and fund a roth ira by April 15, for the 2012 tax year. Open up 410k/ira and start automatic montly contributions.
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