By Damon Poeter
If you’re in the middle of paying down debt or even just getting started, you might believe this prevents you from investing in your retirement – or even investing, period. But don’t buy into this idea just yet.
When it comes to investing, time is your biggest ally, according to Josh Andrews, advice director for military life advice, investments and education at USAA and a CERTIFIED FINANCIAL PLANNER™ practitioner.
If you don’t start investing (even in a small way) until your debt is paid off, you’ll miss out on all those months and years an investment could have been making you and your family money.
“Start Early, Start Small and Stay Committed”
“You’ve probably heard about ‘pay yourself first.’ It’s a smart thing to do,” Andrews says.
“Pay yourself first” is a strategy you can use to set aside a portion of your income for financial goals like saving, investing and paying down debt before spending anything or paying any bills that aren’t a part of a debt payment.
Many people find that if they pay everyone else first, there’s rarely any money left over for their financial goals. If you can stick to setting aside money from your paycheck for financial goals before it’s used for anything else, you might find your savings and investments growing faster than expected.
The beauty of it is that you don’t have to save and invest all that much each month to start seeing potential returns, as long as you stick with the plan. And starting early may not only grow your portfolio faster, it can accelerate the rate at which it grows.
A savings account, for example, gives you interest on the money you have in it – meaning every time the interest is compounded, it’s delivering more money back, and you don’t even have to work for it.
“Start early, start small and stay committed,” Andrews advises.
You’re trying to arrive at the best possible ratio between the amount you use to pay off your debt and the amount you save and invest.
What this means is you want to avoid two kinds of situations:
Scenario 1: Money that would have been better used to quickly pay down high-interest debt is put into savings or investments. People sometimes take out high-interest, payday-type loans that carry finance charges as high as 30% and must be repaid in very short timeframes.
For example, if you took out $100, you might have to repay $130 in just two weeks. Such loans often allow you to roll over the payment to a later date – but be careful. Rolling over a payday loan means additional finance charges that are calculated against the interest owed on the loan as well as the principal.
If you’ve rolled over your loan for another two weeks, instead of owing $130 you now owe $130 plus another 30% finance charge on that $130, or $169. Roll it over again and you’ll owe $220 just six weeks after taking out the loan – or $120 in interest just to borrow $100. Such a debt cycle can quickly get out of control.
Saving should always be a priority. But if you are carrying a payday loan debt, it’s often better to commit all of your resources to paying it down as quickly as possible and starting your savings regimen later.
Scenario 2: You’ve been aggressively paying down debt, but you don’t have emergency cash or your retirement is underfunded. It’s important to decide on a manageable amount to put toward debt reduction, emergency money and retirement savings.
It’s a good idea to work toward building a financial cushion or emergency fund of $1,000, Andrews says. Try to figure out how you can achieve that goal within a set timeframe – say six months or a year – while still paying down your debt.
Figuring out the right ratio of debt repayment to savings will depend on your circumstances. Make sure to save something every month, even if it’s a small amount.
Pay Yourself First: Set up your emergency savings fund of at least $1,000. Put aside some money for retirement in an IRA and contribute to any 401(k) programs your employer may offer.
Get Life Insurance:Next, protect your family with the right types of coverage, such as life insurance, to ensure they’ll be able to maintain their regular lifestyle and pay off your outstanding debt in case the unexpected should happen. A permanent life insurance policy can also serve as a kind of savings account you can draw from later in life.
Set Debt Priorities: Remember the First Law of Holes: If you find yourself in a hole, stop digging. Paying at least the minimum on your debts, on time, is priority No. 1. Priority No. 2 is paying any extra you can on debts with high interest rates.
Remember to start small and stay committed. “You could allocate $100 extra to debts – $50 a month toward savings and $50 a month to retirement,” Andrews says.
Here’s a sketch of how a typical investor who’s starting out might grow a portfolio over *time:
• Our first-time investor has been paying down debt and starts small with retirement savings by putting $50 a month into a 5% return investment vehicle for five years
• In Year 6, our investor gets a raise at work and starts putting $75 a month into her portfolio
• In Year 11, she gets another raise and begins investing $150 a month for her and her partner’s retirement
• By Year 16, her kids have started to become more financially independent and she’s able to commit $300 a month toward her portfolio for as long as she’s working full time
In this example, our hypothetical investor would wind up with about $180,000 (before taxes and inflation) in 35 years after her first $50 investment, so long as the 5% annual return rate on her portfolio stayed steady. The key thing to remember is it was all made possible because she started early, started small and stayed committed with that first five years of investing $50 a month.
You can see how getting started early with both savings and investment is important, because your financial portfolio can really start to grow over time, as long as you stick with your plan.
Andrews has one last piece of advice: Paying down your debt, creating a financial cushion and jump-starting your long-term investment portfolio doesn’t mean you don’t get to have fun in the here-and-now.
“Let’s say you get a raise at work. It’s always smart to save and invest the money from the raise instead of increasing your spending – but do carve out a little bit, say 5% to 10%, for celebration/fun money,” he says. “You should build for the future, but you also get to have fun in the present.”
* This chart is a hypothetical illustration and is not an indication of the performance of any USAA product.
Josh Andrews is the advice director for military life advice, investments and education at USAA and is a CERTIFIED FINANCIAL PLANNER™ practitioner. A native of Cullman, Alabama, Josh earned his bachelor’s degree in engineering from the United States Air Force Academy and his master’s degree in financial planning from Kansas State University. Prior to joining USAA in August 2011, Josh served for 11 years on active duty in the Air Force and is currently a lieutenant colonel in the Air Force Reserve, where he serves as the director of USAFA admissions for South Texas.
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This material is for informational purposes. Consider your own financial circumstances carefully before making a decision and consult with your tax, legal or estate planning professional.
Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the United States, which it awards to individuals who successfully complete the CFP Board’s initial and ongoing certification requirements.
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