how to prioritize your savings when you’re fresh out of college (and later)

Now the real education begins.You’ve got a shiny diploma, thousands of dollars in student loan debt, and a dozen friends and relatives who each have their own idea about where your money should go. Buy a house! Pay off that student loan! Save for an emergency fund! Invest in your 401(k)! And, somehow, have money left over for, you know, food and stuff!

Fear not: I’ve got a system that can help.

Start off by putting a minimal amount towards every savings goal you have. You heard me: all of them. And when I say “minimal”, I mean it — even if it’s only 0.5% of your  paycheck into your 401(k), the minimum payment on your credit cards, and $20/month for your emergency savings fund, put something away towards each of your goals. The idea here is that you start saving right now, thus taking advantage of the mysterious force of compound interest that makes for interesting graphs like this (from this post). (And yes, compound interest has the same effect whether you’re talking about debt or saving.)

Of course, even compound interest isn’t magic enough to fund your retirement on 0.5% of your paycheck. Which is why the next steps are critical:

Every six months, increase the amount you’re putting away by a set amount. It doesn’t have to be a lot, but by periodically increasing the amount  you put away, you can slowly ramp up to your goal in small, painless increments. The money that would normally go to “lifestyle inflation” will instead go quietly, steadily towards your savings goals.

For instance, you might add 0.5% to the amount of your paycheck going towards your 401(k) every six months. In ten years, you’ll be putting an extra 10% away towards retirement, something a lot of people in their 50’s can’t say!

Meanwhile, choose your Most Important Goal and focus on that. All your savings goals are getting some attention; pick the most important one and give it some extra love. Allocate more of your budget to it; put a high percentage of all “found money” there (the rest you can spend on whatever you want, as an incentive to “find” more); in general, make it a high priority. Once that goal is taken care of, move on to another, and so on. This way, while you’re slowly building momentum on your other goals, you’re always focusing on the most important one. A suggested priority list for a new grad:

  1. One-month buffer
  2. High-interest debt, in order of size (snowball) or interest rate, whichever motivates you more
  3. Emergency fund (3-6 months’ basic living expenses or more, depending on your situation)
  4. Mid-sized savings goals, like your next car or the down payment on a house
  5. Low-interest debt
  6. Retirement

By the time you’ve worked your way down to “low-interest debt”, you should be in really good shape. Will it take a while? You bet. That’s the beauty of long-term goals, though — you have a long time to get them right!