Updated on 07.31.14

Make Sure The Left Hand Knows What The Right Hand Is Doing: The Simple Dollar’s Guide To Assigning Priorities

Trent Hamm

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.

Loading Disqus Comments ...
Loading Facebook Comments ...
  1. kingking says:

    It should be noted that most 401k and some 403b plans will allow a participant to borrow 1/2 of the vested balance (up to $50K), without paying a penalty. However, you must remain with your present employer long enough to repay the loan, or you owe the penalty and taxes on the money. Some plans also place restrictions on the usage of the money such as education or medical expenses. James should check with Human Resources or his plan administrator to see if he qualifies for a loan, rather than just coughing up the 10% penalty from the start.

  2. MossySF says:

    I don’t want do judge with details but two phrases stand out as red flags “5/1 ARM” and “pay down debts”. The only debt that can put your house at risk is a mortgage or a HELOC. You decide to not pay your credit cards — all they can do is call you nonstop and then get a judgement against you. Except your retirement and house is still protected — you declare BK and laugh at them from the living room of your house while monitoring your 401K balance.

    So just those two phrases say borrower qualified at the ARM’s initial rate but the house in reality not affordable to the borrower after reset. The problem is not 15% 401K contributions but buying the house in the first place. Otherwise, what would have been the big deal about stopping the 401K contributions and then redirecting the money to the mortgage? The non-ethical solution — since credit is shot anyways, stuff as much money into protected assets like the 401K and let the bank take the house back while you live in it for rent-free for 6 months or more.

  3. Brip Blap says:

    It’s a frightening concept to think how many people are trying to do their best to save while managing horrific debt. I think paying down debt (unless it’s student loan debt OR a mortgage) is always first priority, then save. To some extent that’s just my own opinion, but I really think that letting someone else have “true” ownership of your assets is crazy. I wish I could pay off my mortgage and then I would be literally debt-free, but I’ve chosen to keep that debt and invest my money elsewhere. I do sometimes wonder, though, if I should plow all of my savings into making myself COMPLETELY debt-free. Tough story.

  4. Jimbo the Great says:

    I’ve just begun my own personal journey to financial health and am trying to sort out all of the new info (I promise, this is mostly on topic). My wife and I have been seeing a therapist for post-partum issues and she says that a lot of our problems are from money (you don’t need a degree to figure that one out). We have about $850 saved and about $12,000 in credit card debt. She’s told us that we need absolutly no savings and that we need to pay off our debt. What does everyone else think? Should you have a little bit of money to get you over the rough points or should you just assume you’ll use your plastic for emergencies should they arise. That’s how we got in this boat in the first place.

    Jimbo the Great

  5. plonkee says:

    I think it depends on how needing to use credit in an emergency would affect your debt repayment psychologically.

    If you feel that it would be like taking many steps back and/or would make you feel that you might never pay off your debts then have a small emergency fund.

    If on the other hand, you can focus your attention on your networth then you from a numbers / financial point of view its better not to have savings and to pay off debt.

  6. Dan says:

    As hard as I try I can’t seem to be sympathetic to people who bought too much house on ARM mortgages…ARM mortgages have always been a poor idea unless you are a pretty sophisticated buyer. For the rest of us amateurs, 30 year, fixed, no prepayment penalty is the way to go.

    Sure, you might save some money there initially, but you do it at the expense of your future if you don’t time your refinance or sale exactly right. Without a crystal ball who can predict their circumstance 5 years down the road?

    @Jimbo – Don’t take money advice from a therapist (I don’t even think it is professional/ethical for them to offer it) – take it from me instead

    If you build up a emergency fund (maybe $1000)then you can pay for emergencies from your fund instead of running your credit card debts back up. You don’t pay interest on money you take from savings. Arguably, you are paying interest on the credit card balance that you have not paid off, but it feels better to not undo your progress on the credit card front and you can off-set this to a degree by putting your savings into a intrest bearing account like the ones Trent always mentions (ING, HSBC, etc).

    I ended up with substancial credit card debt by not having an emergency fund, I’d pay for each emergency with credit cards then never pay off the cards, now I have “seen the light” and it was really cool to be able to buy a new furnace last month without putting it back onto credit cards. My credit card balances are still where they were, and I know my emergency fund will build itself back up in time (pay yourself first, automatically).

  7. Dan M. says:

    Two questions jump out at me.

    If the 5/1 ARM triggered a big payment increase, most companies allow you to reduce your 401(k) witholdings within a month to a quarter. It seems like cutting back on the 401(k) contributions could have happened at nearly the same time as the payment increased.

    The other item is that this situation illustrates the importance of having an emergency fund in a liquid vehicle like a savings account (or even CDs since you don’t intend to access the money and can afford the penalty if you need it quickly). An emergency fund is critical in the event you lose your job or have any unforseen expense (including an ARM reset).

    Both of these options should have given James enough time to sell or refinance the house.

    BTW, I went with a 7/1 ARM because at the time it was $100 cheaper on monthly payments than a 30 year fixed. Rather than spend the difference, I’ve made the same payment as the 30 year would have been which has meant I’ve been paying 33% more towards principal each month. If I hadn’t already had an emergency fund, then this extra cash could have been used to establish one.

    Now, an ARM was not the best call if there was a very high chance I would be in the home more than about 9 years or simply could not have afforded any increase.

Leave a Reply

Your email address will not be published. Required fields are marked *