One of the challenges successful young professionals face when planning for their financial future is deciding the best ways to use their extra cash to save, invest, and pay down debts. New savers have worked hard and are beginning to realize the financial benefits of their professional success, but are unsure about best way to balance and prioritize their many competing financial goals. This group is sometimes referred to as HENRYs (High Earning, Not Rich Yet).
We’ve recently met with several successful young clients who fit this description. Having reached this stage, they want help deciding the smartest ways to use this extra money to help them improve their financial futures. Below are some common financial goals our young clients often identify. We’ve grouped these goals in what we often suggest should be the highest to lowest priorities.
- Saving for Retirement – At a minimum, we recommend that our young clients take full advantage of any 401k matching provided by their employer. While it is important to save as much as possible, we suggest aiming for 12-16% of their salary. You can see the current retirement account contribution limits here.
- Paying Credit Card Balances– Beyond retirement savings, paying off credit card balances is one of the most important priorities. The average interest rate for credit cards is around 15%. Paying off credit card balances will bring a “return” in the form of interest expense savings. It would be difficult (if not impossible) to find a more certain return on investment.
- Creating an Emergency Reserve– It is important to have money available to cover unexpected expenses. We typically advise our clients to have 3-6 months of living expenses tucked away in a savings account to handle financial emergencies when they arise.
- Building an After-Tax Portfolio – We believe that accumulating wealth outside of traditional retirement accounts is an important part of establishing long-term financial success. This provides financial flexibility as withdrawals from a taxable account can be used for anything and do not have early withdrawal penalties.
- Saving for College – For our young clients with children, it is important to begin saving for college as early as possible. Establishing an education account, such as a 529, and making regular contributions will help a lot down the road when college expenses become due. We discussed the surprisingly high cost of college in a previous blog post.
- Paying off Mortgage –In today’s low interest rate environment, mortgage loans typically charge very low interest rates. In addition, the interest cost is tax deductible, so the after-tax cost of mortgage debt is even lower. We typically do not advise paying off mortgage debt beyond the scheduled payments, unless the interest rate is unusually high.
- Paying off Student Loans – It is common that our young clients have multiple student loans with relatively high interest rates. We typically advise that they consider consolidating and refinancing their loans. They can often do this at a lower interest rate. This will make paying them off simpler and will establish a schedule for paying them off entirely.
- Paying off Auto Loans – Many young people borrow to buy their car. In most cases, the interest rate is low (4% on average), and will be paid off on a set schedule. We typically do not recommend paying off auto loans early unless the interest rate is unusually high.
If you are in the fortunate position of having extra cash flow to save for your future or pay down debt, the good news is that among the items listed above, there isn’t a “bad” place to direct the extra money. Focusing your extra cash flow towards any of the above goals will boost your financial health by either adding to your assets or reducing your debts. Both are great outcomes.
As with any financial decision, you will want to consider your personal circumstances and preferences when determining your priorities. The most important thing is to use the extra cash flow productively, rather than finding new ways to spend. If you’d like help balancing your financial priorities, we would be happy to schedule a meeting or a conference call at your convenience.
Horizon Advisors is a Houston based fee-only wealth management firm. Horizon is a fiduciary advisor. We specialize in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.