I touched on this concept about a week ago when I discussed Maggie’s horror story, but it’s true – when one hand is doing the right thing while the other hand is making mistakes, you can end up in an even worse financial situation because of it.
Take this situation that James found himself in:
I bought my house on a 5/1 ARM about six years ago and now I’m about to lose my house. All the way along, I was contributing 15% to my retirement savings as everyone was telling me that it was the right thing to do, but if I had not been doing that and been trying to pay down my debt instead with some of that 15%, I would not be losing my house right now.
James went on to report that he had in fact decided to tap into his retirement plan, take a big penalty, and use that to get his home financing in the right order – he was in dire straits, but he didn’t really lose his home.
James was doing some things right here. He was contributing a very healthy amount to his retirement fund and he was making a good move towards becoming a homeowner (an arguable move, anyway, depending on your feeling about ARMs). James was doing one good thing with his right hand and another arguably good thing with his left hand, but the two were pulling in opposite directions.
Why did this happen? James had multiple goals, but he didn’t assign priority to them. He clearly was giving both his retirement and his home the highest priority, and because he hadn’t determined which one was truly more important to him, he damaged them both. Because of this unclear set of priorities, James now loses some or all of his retirement savings, loses almost everything he gained on it by paying taxes and the ten percent penalty, and has damaged his credit by being late on house payments.
That’s why it’s important to assign priorities to your financial moves. Reading financial advice can be overwhelming because everyone is touting things like “save 15% for retirement” or “buy a house now!” or “you should be investing in mutual funds” or “how about funding that Roth IRA?” or “what about Junior’s education?” Few people can really juggle all of these things at once, so you have to figure out which ones you’re actually going to follow and which ones can go to the back burner.
So, without further ado…
The Simple Dollar’s Guide To Assigning Priorities
First of all, make a list of every financial goal you have. Everything. If you have any interest in funding a Roth IRA, write it down. Want to save for your kid’s college education? Write it down. Want to build up income-earning investments so you don’t have to work again? Write it down. Want to be debt free? Write it down. Get it all out of your system before you even start. Remember to distinguish between similar goals, like contributing up to your employer’s match for retirement and contributing the max for retirement are two separate, distinguishable goals.
Got them all written down? Prioritize them. Enter them all into the linked tool. After you do that, the tool will show you the items two at a time – pick the one that’s more important to you. After the tool has enough data, it will show you the items as a prioritized list. I know that in the past when I’ve used The Prioritizer, I’ve been surprised at the end ranking at first, but when I really thought about it, I realized it was very spot-on.
Once this is done, realize that priority zero is your basic monthly expenses. This includes minimum payments on all of your bills, plus a bit of pocket money as needed. This is always the highest priority; everything else should follow it.
After that, start going through the priority list. If James had done this, he would have had paying off his home mortgage as a higher priority than extra retirement savings, but a lower priority than mimimal retirement savings (up to his company’s match). So he would have put in the 5% that triggers his company’s match, then put money into getting his home loan paid off. When that loan is done, then James could look at putting a lot of money into his 401(k).
What if it’s not the “perfect” investment scheme? There is no “perfect” investment scheme because of the variability of markets and also because of the human element of emotions and security. The only sure thing is that the less you require for your everyday life, the more you’ll have to pay down debts and invest, so the better off you’ll be in the long run. Don’t worry about whether your list is “optimized” too much – just use some common sense (higher interest rates are more urgent, for example) and stick to a plan and you’ll be light years ahead of the game.