Deciding which one comes first so you know where to focus your efforts
When it comes to personal finance, many competing priorities can make it challenging to determine where to focus your efforts. For many people, the choice between building emergency savings and working towards their retirement goals is one of the biggest dilemmas they face. So, which should you focus on first?
To answer this question, it’s essential to understand emergency savings and retirement goals and why they are both critical. Emergency savings refers to the amount of money you have set aside in a readily accessible account to cover unexpected expenses, such as a job loss, medical emergency, or major home repair. Retirement goals, on the other hand, are the plans you have in place to provide for yourself financially once you stop working.
Both emergency savings and retirement goals are important. Still, the order in which you focus on them will depend on your financial situation. Suppose you have a stable income and few financial obligations. In that case, you may be able to focus more on your retirement goals, knowing that you have a safety net in place in the form of your emergency savings. However, suppose you have limited income and high debt. In that case, you may need to prioritize building up your emergency savings in order to protect yourself from financial shocks.
Emergency Savings First
Here are a few reasons why emergency savings should come first:
- Peace of mind: Having a solid emergency fund in place can help you sleep better at night, knowing that you have a safety net in case of an unexpected expense.
- Protects against debt: If you don’t have emergency savings, you may turn to credit cards or loans to cover unexpected expenses, which can quickly spiral into debt. Building up your emergency savings can help you avoid this trap.
- Provides flexibility: With an emergency fund in place, you have more flexibility to make decisions about your financial future, such as taking on a new job or starting a new business.
Retirement Goals First
However, there are also some good reasons why focusing on your retirement goals first can make sense:
- Time value of money: The earlier you start saving for retirement, the more time your money has to grow, which can make a big difference in the amount you have saved when you retire.
- Compound interest: The power of compound interest means that the earlier you start saving, the less you need to save each month to reach your goals.
- Employer matching: If you participate in a 401(k), or another retirement plan at work, your employer may match a portion of your contributions. By maximizing this match, you can significantly increase your retirement savings.
Emergency Savings vs. Retirement Goals
So, which should come first? Ultimately, the answer will depend on your financial situation and goals.
In any case, finding a balance between the two is crucial. You don’t want to neglect your emergency savings and end up in debt when an unexpected expense arises, but you also don’t want to delay your retirement savings and struggle to make ends meet in your later years. A good rule of thumb is to aim to have three to six months of living expenses in your emergency fund and then start contributing to your retirement goals as soon as possible.