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When financial goals compete – do you have a plan?


Juggling multiple financial priorities and wanting to do it all can sometimes lead to doing nothing at all. As the financial to-do list grows, it can be difficult to weigh your decisions, prioritize, and execute the plan. Should you increase your retirement savings? Start a 529 plan for your children? Pay down student debt? As the questions mount it becomes increasingly important to evaluate your options.

Identify your priorities

Before you can evaluate your situation, you need to identify your financial wish list. Create your priority matrix and include time horizon, the amount you’ll need, and other information, such as interest rates. It is also helpful to explore alternatives during this process which will help you prioritize. For example, if you’re only able to contribute half of the necessary funds for your child’s college education, there are still ways to make up the difference, such as student loans, scholarships, and opting for a less costly public school. Other goals, like a down payment on a home, will need to be fully funded in cash. While you may be able to dip into your IRA or 401(k) to come up with the rest, it is almost always best if you can avoid doing so.

chart

Saving for retirement should generally top the priority list for most people. This will be the largest financial ‘need’ in the future and you won’t be able to get a bank loan to pay for it. Investors will get compounded growth over a long time horizon and there are also tax benefits of many retirement plans.

Narrowing your focus

If you aren’t working with a financial advisor, you’ll need to use your priority matrix as a starting point. Based on your budget, determine what you can afford to save each month after your other expenses, taxes, and contributions to retirement accounts. (If you don’t have a budget,here are some apps that may be able to help.) Once you have the amount of available funds you have to work with each month to meet your goals – the analysis begins.

Although it is advisable to have a financial professional conduct an in-depth analysis to understand your complete financial picture, a quick personal analysis can help you narrow your focus. Using the question of whether you should prepay loans or invest as an example, here’s a sample analysis using the matrix above:

Should I prepay? Based on the chart, it likely wouldn’t be advisable to use any “extra” monthly cash to prepay the car loan, mortgage, or student loans, when you can invest the money instead.

Why?

Assuming your credit is in good standing, the interest rates on each of the loans are less than what you could earn investing the money, given the return assumptions.

Suppose you invested $100/month instead of prepaying the student loans. After 20 years it would have grown to over $50k¹. At 5.5% interest, paying an additional $100/month on your student loans will save over $10k in interest and shave 8 years off your 20-year loan term. Now assume you take those 8 loan-free years and begin to invest $100/month to equalize the contributions in each scenario. With the shorter time-horizon, the investment will yield under $13k² for a combined total of $23k³.

It’s complicated

As you can tell, analyzing competing priorities is fairly complex and involves many factors not included in this sample analysis. In reality, all your competing goals have different tax benefits (and consequences), levels of urgency, and available alternatives. Also, while analyzing two options may help you decide the better of the two, it won’t necessarily help you develop and track your progress towards multiple goals, an essential component of any comprehensive financial plan.


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¹Assumes average annual 7% return, excluding taxes and inflation.
²Excludes impacts of taxes and inflation. Also assumes average annual 7% return.
³Excludes impacts of taxes and inflation.
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Comment   |  4 years, 3 months ago from Boston, MA