How to Balance Saving for Retirement, Emergency Fund, and Paying Off Debt

By Christa Avampato. Last updated 17 September 2014. 3 comments

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Balance in our financial lives can feel like a dream we'll never reach. Do we pay off student loan debt? Make an extra payment on the mortgage or the car loan? Should we save for retirement? How much do we need to have in an emergency fund? There's a lot of conflicting advice out there. (See also: Investment Advice You Shouldn't Hear From Your Financial Advisor)

When I graduated from business school and arrived solo in New York City with a $0 balance in my bank account, $100,000+ worth of student loan debt, and no job in the summer of 2007, I faced all of this confusion head-on and with a mountain of anxiety. Six and a half years later, I have roughly 12 months of savings in my emergency fund, paid off over half my student loan debt, and run my own content development business after quitting my corporate job 19 months ago.

Along this winding path I learned that balance, financial or otherwise, is a process, not a state of being. Priorities will shift and unexpected changes will arise. That's life. The best thing you can do is develop and commit to a plan that's flexible enough to allow for some shifting and stable enough to give you confidence and peace of mind so you can live life to the fullest. Here's the blueprint I used to find financial balance, and you can use it, too. (See also: Creating a 5-Year Financial Plan)

1. Your Emergency Fund Is a Lifeline

If you get sick, lose your job, or transition to a new home or career, an emergency fund is the shock absorber that makes these changes manageable. It's meant to help you keep a roof over your head, food on the table, and your credit score intact when the going gets tough.

Some people will say you need three months of savings. Others will say you need a year, and every amount in-between. The truth is that it's your choice. How much do you need to feel safe and secure in case of an emergency? When it comes to personal finance, I'm very conservative, so I want a year's worth of living expenses saved. If this feels daunting, don't worry. You build up this fund in small amounts over time. How much can you put away every week and not touch? $25, $50, $100? Commit to an amount you know you can manage, and start building. (See also: Emergency Fund Guide)

2. Grab That 401(k) Match or Set Up an IRA

If you work for someone else and your employer offers a 401(k) match, contribute as much as you need to contribute to get that match. It's free money. Don't leave it on the table.

If you don't have an employer match or you work for yourself, you still want to start putting aside some money (even if it's a very small amount every month) for retirement as soon as you can to take advantage of compounding interest over time by setting up an IRA or ROTH IRA. 

3. Credit Card Debt Must Go, but Keep the Cards

Credit cards, when paid off every month, can help establish credit history, bolster a credit score, and deliver valuable rewards. When not used properly, credit card debt is often the costliest expense in our portfolios and certainly the most damaging kind of debt for a credit score. If your cards carry a balance, take these steps:

  • Call every credit card company you use and negotiate a way to pay down your debt as fast as possible and in a manageable way. They will work with you if you open up the conversation.
  • Part of your credit score comes from examining the amount of credit you have access to and the amount you use. The greater that ratio (you have access to credit and choose not to use it), the more discipline and responsibility you demonstrate. The best way to destroy this ratio is to cancel your credit cards. Don't do it. Work on paying them off and then put them in a drawer for safekeeping.
  • Don't add new charges to a credit card until it's paid off, and then limit the charges you incur going forward.

Next Debt Steps

Examine the rest of your debts and make a chart with the following information:

  • Principal remaining and monthly minimum payment;
  • Interest rate and the percent of your monthly payment that goes to interest and not principal;
  • Whether or not your interest payments can be deducted from your taxes.

If you have trouble finding any of this information, just call your lender and ask for it.

When you pay any amount above the monthly minimum payment, that extra money goes directly to principal and that helps you pay down the whole loan faster. If you have extra funds remaining after you've set aside emergency fund money, contributed to retirement to get your employer match, and paid off your credit card debt, then make some extra contributions above the minimum to pay down your other debts in the following order:

  1. Debts that carry interest payments that can't be deducted from taxes (i.e., car loans). Mortgage debt and education debt can be deducted from your taxes and carrying that debt allows you to use cash more effectively.
  2. Debts that have the highest interest rates.

4. Now, Let's Have Some Fun

If you've gotten this far, congratulations! You've set yourself up in a very financially stable position and now it's time to enjoy some of your savings with an additional account. This savings account is for things you want to do — go on vacation, take a class, or redecorate your home. This is money you use to reward yourself for a life well-lived. (See also: 21 Frugal Ways to Reward Yourself)

Personal finance can be, and should be, fun. You're taking responsibility and establishing your independence. You're creating a life that's stable and secure. This is an incredible path with an end goal that you can and will accomplish. Keep track of your progress and celebrate your successes along the way. It's a marathon, not a sprint. Enjoy the journey.

How do you balance the conflicting demands on your income? Does your list of priorities differ from this one?

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Guest's picture

Solid advice!

I think a lot of people don't realise about the credit used:credit available ratio.

I only learned this when I was extended more credit on my Amex I called to reduce it back down again. If it is reduced, it apparently doesn't show if that is due to the individual pro-actively doing it, or the lender taking credit away, hence can be perceived negatively! They were very straightforward in explaining this to me, which I was pleasantly surprised at!

Christa Avampato's picture

Thanks for your comment, Pip. I am so glad to hear that Amex explained that to you. I worked for Amex for 4 years (and have been a cardmember for 16 years) and I can say from an outside and inside perspective that their servicing is second to none. I wish the advice they gave you got more publicity - it's one of the things that makes FICO scores so difficult to understand.

Guest's picture

How do you balance them since they are competing for your discretionary income?
I trying to prioritize the below items , in no particular order

Item, rate if it gets 100% of discretionary, current discretionary
Student Loan Debt (24 months if I put all of my money into it ) - paying standard payment + 10% of discretionary
House Down Payment( (6 months if I put all of my money into it ) - gets 70% of discretionary income
Emergency Fund(7 months if I put all of my money into it ) gets 20% of discretionary

No other debts besides student loans.