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 Post subject: Priorities: Debt, Retirement, Emergency?
PostPosted: Tue Aug 21, 2012 2:09 pm 

Joined: Tue Aug 21, 2012 1:33 pm
Posts: 21
As a general question, how do you prioritize? Once you've spent what you need to and what you want to (in your balance money formula for example) how do you decide what to do with the "savings" chunk? Debt, long term/retirement, or emergency? What factors do you consider?

Specifically, here is my situation.
I recently moved from a low paying job to a better job. I have a law degree and am now working as a lawyer. I am 28, single, no kids and none on the horizon. The delimma now is whether to join the 401K at the firm. The 401K has no set matching but does say that the firm could put money in. I don't think that's worth counting on, but could follow up to see if they usually do or usually don't.

And the financial picture:
25,000 in private student loan debt at about 5% interest.
75,000 in federal student loan debt at 6.75% interest on income based repayment.
(Student loan payments today total about $350 a month, and will go up to about $750 next year based on the new job)
13,000 car loan with $375 month payment (at 4%)
$2,000 in savings in a money market account.

Lets assume I have about $350 a month additional in my budget that I can send to something. I could increase my car payment, and pay it off in 2 years instead of 4.5. I could increase my private student loan payment, or my federal student loan payment. Both are on 25 year plans and they seem so insurmountable. My emergency fund is about 1 month of expenses. Should I be putting $100 a month or more in to the 401K?

I hate to "waste" the years of available 401K, but it seems like it would be a better plan to get my E-fund up to $4,000 or $6,000 and then pay down the private student loan (which can't be deferred and won't be automatically forgiven after 25 years.) But $2,000 is enough for most non-job loss emergencies and not saving for retirement seems irresponsible.

Going forward what is my best choice?


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Tue Aug 21, 2012 2:38 pm 
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I think you need to build up your EF to at least about $20000 to cover several months of loan payments and other expenses. While doing that you should read a few personal finance books and think about the next steps.

You have a lot of debt but it is long term and it served you well by getting you a law degree. I'm not so sure I'd be in a hurry to pay it off over investing for retirement. I might because the interest rates are fairly high, but I don't think it is an obvious choice.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Tue Aug 21, 2012 3:28 pm 

Joined: Wed May 30, 2012 11:56 am
Posts: 132
The big question is, what do you want to do? There's no reason you can't do more than one thing, you can pay extra to your debt while contributing to retirement. If you don't think you have enough extra in the budget, maybe there's money being spent on something else - cable, coffee, etc - that you would rather put to savings or debt.

Personally, I would recommend putting something into retirement and beef up the savings, the general consensus is that you should have 3-6 months of expenses but ultimately it needs to be a number you're comfortable with. You can tackle the debt at the same time or divert the EF savings once the account is where you want it.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Wed Aug 22, 2012 6:36 am 
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Joined: Thu May 17, 2012 10:05 am
Posts: 1076
I agree buff up your E-Fund. Then decide how you're going to get out of debt. If the 401k is not matched I'd either pay off debt or invest the money. I also think some good PF literature would be a good idea.

See this thread for a game plan on getting out of debt.

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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Wed Aug 22, 2012 9:02 am 

Joined: Tue Aug 21, 2012 1:33 pm
Posts: 21
Eagle, the thread you mention is based on the Dave Ramsey method. I know that process, and my roommate is on the plan. That's one of the reasons I asked this question. My emergency fund is obviously above the first round emergency fund he suggests. His plan seems to be really motivating for people with many smaller debts, and less motivating for me with only 3 large ones and no credit card debt. Yes, lets say I really buckle down and can pay off the car in 1 year, the private loan in 2 more. Hurray. Now I have about 7 additional years of the same austerity for the larger loan. 10 years of that doesn't actually sound better than 20 or 25 years of more expensive (in interest) balance. Especially since I spent the last 10 years living on a student budget with a broken down car, no pets, and a strict budget in low rent apartments.

Maybe after a year of ridiculous excess like buying full price items at the supermarket and driving a reliable car, (along with not panicking whenever an unexpected expense comes up) I'll be ready to buckle down again. But for now the $350 above payments is what I have.

It sounds like a larger emergency fund is the general consensus.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Wed Aug 22, 2012 11:24 am 

Joined: Tue Jun 12, 2012 4:34 pm
Posts: 521
If it were me, I would split the extra $350 between building the e-fund and starting a retirement account. Look at your employer's plan carefully; if the fees are high, I'd skip that and open an IRA or Roth IRA (depending on your income). Remember, if you go the traditional IRA or 401k route, those contributions are pre-tax, which will reduce your overall taxable income, giving you a little more money in your month. (The interest on your federal student loan debt should also be tax deductible.) Once your e-fund is at a comfortable level (whatever you decide that is), then I'd start throwing the extra at the debt.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Wed Aug 22, 2012 12:49 pm 

Joined: Thu Dec 30, 2010 4:59 pm
Posts: 62
Location: San Diego, CA
StarryC wrote:
Lets say I really buckle down and can pay off the car in 1 year, the private loan in 2 more. Hurray. Now I have about 7 additional years of the same austerity for the larger loan. 10 years of that doesn't actually sound better than 20 or 25 years of more expensive (in interest) balance. Especially since I spent the last 10 years living on a student budget with a broken down car, no pets, and a strict budget in low rent apartments.

Maybe after a year of ridiculous excess like buying full price items at the supermarket and driving a reliable car, (along with not panicking whenever an unexpected expense comes up) I'll be ready to buckle down again. But for now the $350 above payments is what I have.

It sounds like a larger emergency fund is the general consensus.


Oh woe is me! My debts are so big that I'm just going to ignore them and live the way I want to live. That'll make me happy!

WRONG attitude.

1) You're starting lifestyle inflation already (13k car loan, changing consumer habits). Now is a golden opportunity to tackle your debt while the higher income is still new to you.

2) If you really buckle down it's not going to be 1, 2 and 7 years unless you really expect 0 pay increases in your next 3-5 years of working. Unlikely.

3) You're my age. In the next 10 years you're likely going to want to own a house. Are you ready to just pile more debt on to your outstanding school loans? You mention no kids in your immediate future. Are you married? Do you want to be? Regardless, chances are life is only going to get more expensive from here on in.

4) You say you lived some deprived live during college? So? You deal with the situation you are in. You make the best choices you can and you live with the consequences. Period.

I guess what I'm saying all boils down to this. Don't be a consumer sucker all your life. You're starting to make some money now, great. Now do yourself a favor and get out of debt!

Oh and you might want to look into enrolling in the 401k even if you don't decide to contribute. At my company there are "optional" contributions made annually as long as you are enrolled. If your company does the same thing, you'll want to capture that money.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Wed Aug 22, 2012 2:43 pm 

Joined: Tue Aug 21, 2012 1:33 pm
Posts: 21
I'm definitely not saying woe is me. I made these choices, and I feel ok about them. I'm not ignoring my debts. I'm paying them, and I'm considering doubling my payments to them. They aren't revolving, I've stopped digging. I'm saying, the choice I am making now is to contribute this much for this long and re-evaluate when things change. (Kids and marriages seem to have at least a 9 month gestation period, and I don't want to count on a raise.) The question is with this much, where should I contribute it? Savings, retirement, or debt?

Yes, sure, I could do all kinds of additional things. I'm sure everyone could go farther. You have probably decided not to become a "freegan" or not to clip coupons or not to walk to work. I have decided to only cut expenses by $350 a month. Maybe in 6 months I'll decide I have $500 or $1000 a month. But today, $350.

AlohaBear, I am definitely thinking about taxes and thanks for the tip on fees. I didn't even think to compare it with something else, since it's the plan that was delivered to my desk.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Wed Aug 22, 2012 5:55 pm 

Joined: Thu Dec 30, 2010 4:59 pm
Posts: 62
Location: San Diego, CA
StarryC wrote:
I'm definitely not saying woe is me. I made these choices, and I feel ok about them. I'm not ignoring my debts. I'm paying them, and I'm considering doubling my payments to them. They aren't revolving, I've stopped digging. I'm saying, the choice I am making now is to contribute this much for this long and re-evaluate when things change. (Kids and marriages seem to have at least a 9 month gestation period, and I don't want to count on a raise.) The question is with this much, where should I contribute it? Savings, retirement, or debt?


I'll try not to reiterate myself too much. I'm not saying you made a bad choice or all debt is bad and must be paid at all cost either. Just that you should feel like this high (to me) interest is sucking you dry that it's easier to attack them now rather than when you've come accustomed to a higher income.

Paying an extra 350 on the school debt is only technically paying double since they are going up to about 750 next year anyway. I'm throwing down the gauntlet and saying you can do better than that (not having seen details of course).

But if you just want your question answered and don't want anyone attacking your decisions. This is what I would do regardless of amount saved:

0) If there was a match on the 401k then I would take it up to the match. Otherwise pass.

1) Save enough where to feel confident that in the event of a lost job there is enough to get by until a new job can be found. (If you can live on 2k a month like you say then I might go with the nice round number of 10k)

2) Pay down the debt on anything with an interest rate over the rate of a 30 year mortgage (currently 3.6%).

3) Open a Roth IRA from Vanguard and split the savings between retirement and saving for a down payment on a house (assuming you want one).

StarryC wrote:
Yes, sure, I could do all kinds of additional things. I'm sure everyone could go farther. You have probably decided not to become a "freegan" or not to clip coupons or not to walk to work. I have decided to only cut expenses by $350 a month. Maybe in 6 months I'll decide I have $500 or $1000 a month. But today, $350.


Sure, I'm not questioning your ability to make decisions or saying I'm the perfect example of frugality. I'm just kindly pointing out that THERE IS A GIGANTIC BLOOD SUCKING LEACH ON YOUR NECK and you might want to do something about sooner rather than later.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Thu Aug 23, 2012 12:40 pm 
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Joined: Thu May 17, 2012 10:05 am
Posts: 1076
I think the best thing to do is to take it slow. Get rid of the debt as best you can. When I got a new job we more than doubled our income. Yet we're actually spending, on average, less than we used to before the job change.

StarryC will have to decide the work/life/debt balance that works for her.

Get started on the E-Fund. Then start knocking out the debt. Good luck! :)

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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Fri Aug 24, 2012 1:59 pm 

Joined: Mon Jul 30, 2012 3:59 pm
Posts: 28
Starry,
This is what I'd suggest:
1. Save the extra $350 and whatever else you can get your hands on until you have 6 months of living expenses as an EF
2. Start reading a mix of PF, How to Buy/Not Be Sold, and Emotional IQ books while you build your EF
3. Hopefully, by the time you've reached the EF goal, you'll understand what drives your buying habits and enjoy a life of good control on your finances and spending.
4. Put every excess dollar toward the most expensive student load (the 6.75% one)
5. Then start paying off the next most expensive loan and continue to work your way down the list until you have no debt. I'd defer on a house or any other purchase until you're out of debt.

I would often place retirement at the top of the list but if your firm does not match, then make that next after you pay off the debts. Returns on your retirement savings, in the current economic environment, are not as high as the cost of your debt.

Meanwhile, take care of your car with good preventive maintenance because you'll want it to last until you pay off your loans.

If you can do this, you'll be debt free at a still young age and have lots of options available to you.

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www.dontgopoor.com
SOLD: Don't Go Poor and Miserable Being Sold Happiness - teaching consumers how to buy


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Fri Aug 24, 2012 5:15 pm 

Joined: Tue Aug 21, 2012 1:33 pm
Posts: 21
Thanks for the tips. I didn't realize so many people thought a 6 or more month emergency fund was such a priority. I feel like I often the 1000 or 2000 figure and then debt as the second priority, then a large savings after that.
I hate home maintenance and yard work, so I will feel fine if I never buy a house. My plan is definitely to drive my car for at least 8 more years.

I feel like I'm in control of my finances and aware of where my money goes. I understand how interest works, and know the cheapest and fastest way to pay it off is to pay the higher interest loan first. However, I also hear a lot about the Dave Ramsey plans, which is why I suggested paying off the smallest actual debt first. On the other hand I see people criticize DR because he doesn't put retirement earlier. It seemed that the more I read, the more contradictory advise I got about how much to save before paying down debt or whether to prioritize retirement.

I'll be asking if the firms vague contribution term has actually been used for them to make contributions, but my guess is no. They are pretty cheap. (And I bet my lawyer salary is not as high as you may think. My teacher roommate makes more than me, so $350 a month is not pocket change.)


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Sat Aug 25, 2012 1:52 pm 

Joined: Sun Aug 12, 2012 4:48 pm
Posts: 5
StarryC wrote:
Thanks for the tips. I didn't realize so many people thought a 6 or more month emergency fund was such a priority. I feel like I often the 1000 or 2000 figure and then debt as the second priority, then a large savings after that.
I hate home maintenance and yard work, so I will feel fine if I never buy a house. My plan is definitely to drive my car for at least 8 more years.

I feel like I'm in control of my finances and aware of where my money goes. I understand how interest works, and know the cheapest and fastest way to pay it off is to pay the higher interest loan first. However, I also hear a lot about the Dave Ramsey plans, which is why I suggested paying off the smallest actual debt first. On the other hand I see people criticize DR because he doesn't put retirement earlier. It seemed that the more I read, the more contradictory advise I got about how much to save before paying down debt or whether to prioritize retirement.


From what I can tell, Dave Ramsey cares most of all about getting rid of any and all debt as quickly as possible and then avoiding all future debt, regardless of the relative risks, benefits, costs, etc. To some degree, that makes sense if you've built up a large number of debts relating to consumption (CCs, store cards, luxury car loan, etc). Just as alcoholics should stay away from booze, those who cannot control their spending should avoid credit.

Were it I, I would build up the emergency fund first. I don't know how secure your job is, but my understanding of the overall market for new lawyers is pretty dismal. Once I got the e-fund up to a minimal level, I'd start directing some of that money into retirement (401k if matched, whatever was best tax advantaged after that). I would also evaluate my budget and see if I could cut enough to get that extra amount increased a bit. Without seeing your entire budget, its hard to evaluate, but that seems like a small amount of extra cash for a lawyer.


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Sun Aug 26, 2012 5:23 am 

Joined: Mon Jul 30, 2012 3:59 pm
Posts: 28
StarryC wrote:
I didn't realize so many people thought a 6 or more month emergency fund was such a priority.


The idea, for most folks, is to prevent needing to borrow money quickly. That type of borrowing is very expensive and creates a financial burden that is tough to remove.

For me, I find that the fund not only provides a nice safety net should something bad happen, but it gives me the ability to dip into that fund to buy cheaply when everyone else is scared and selling. But I keep a 1-year+ safety net. ;)

_________________
www.dontgopoor.com
SOLD: Don't Go Poor and Miserable Being Sold Happiness - teaching consumers how to buy


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 Post subject: Re: Priorities: Debt, Retirement, Emergency?
PostPosted: Sun Aug 26, 2012 6:26 pm 

Joined: Sat May 14, 2011 9:44 am
Posts: 139
Hey OP,

Welcome to the boards! I was in a similar position as you. I graduated with a nice professional degree that would hopefully open up doors for me in the future (and it has). I also graduated with what I considered to be a decent chunk of debt. Upon getting a better paying job, I was faced with a choice... do I "work" on my debt for the next 10=20 years or do I go crazy for a few years and do everything possible to knock it out quickly?

I'll spare you the details, but I will tell you that I chose the latter. I lived on about half of my income and used the rest to quickly get out of debt.... and within a few years I did just that. For me, my debt was truly an emergency... not something to just "work on." Now, having a family, I am SO glad that I chose to tackle this now. The money I make is my money and it has given us freedom we wouldn't normally have had. Let me tell you this... life will only get more complex. The younger you are, the easier it will be to eliminate your debt.

Here's a helpful post from another personal finance site which may give you something to consider from a phycological perspective. While I agree with the others that you need to buff up your EFund ASAP, I'd seriously consider going hard-core on your debt now and just be done with it in a few years.

http://www.mrmoneymustache.com/2012/04/18/news-flash-your-debt-is-an-emergency/

Good Luck!


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