It's never an easy question to answer. What should you save toward? Should you save only for retirement? Should you save for college first and then retirement? Should you save for college and retirement at the same time? Or should you adopt some other savings strategy? In a world where money may seem tight, picking and sticking with a savings strategy could be the difference between reaching your goals or not. But how should you prioritize your savings? Which savings strategy is best for you?
According to FPA member John Salter, Ph.D., CFP®, AIFA®, most Americans have only certain resources —income and assets — to allocate to current needs and future goals. "I believe people should first sit down and think hard about their future goals, and be as specific as possible," he said. "What kind of retirement do you want? What type of college do you want your children to attend? You should have specific ideas of what you are saving for in light of available resources."
When thinking about those goals, he recommends analyzing what would happen if one goal is funded but not the other. "For example, I might first think that funding for my children's college is my top priority," he said. "However, what would my retirement look like? Would I have enough time to save for my own retirement? Or, further, will I fund my child's college only to find out that I will need to rely on them financially in the future because I hadn't saved enough for my own support?"
When thinking through your priorities, Salter suggests that you weigh the future issues that may arise from funding one goal but not the other or others. "The fallback of retirement income is Social Security which may not meet a desired retirement lifestyle," he said. "College, by contrast, can be financed through financial aid, loans, parent's excess cash flow, children's jobs, and the like."
As a rule of thumb, however, FPA member Michael Kitces, CFP®, MSFS, CLU, ChFC, publisher of The Kitces Report and director of financial planning at Pinnacle Advisory Group, suggests prioritizing in this order:
- Save for your emergency fund;
- Save in your 401(k) plan, or at least enough to get the full match from your employer;
- Pay down your high-interest debt.
After that, he suggests funding your short- and intermediate-term goals and then any other goals, including retirement. "Depending on your priorities, you might consider saving for your retirement goals before your short- and intermediate goals," he said.
Deciding how you should prioritize your savings does require some number crunching. For its part, FinAid details a strategy to maximize your cumulative after-tax return on investment. Other sites offer suggestions on prioritizing savings, including Mint.com and America Saves Week.