Dear Liz: We’re a newly married couple with an 11-year-old and hope to have another baby soon. We have $20,000 in emergency savings, $40,000 in investments, $480,000 in retirement funds, $20,000 in low-interest student loans and $43,000 in high-interest credit card debt. If we have another child, we’d like for my wife to be able to stay home. I am struggling with how to prioritize debt reduction, college savings, home improvements and building our emergency fund. I don’t want to tap our savings or investments, as there are often surprises in life and I do not want to be caught short. The problem is that aggressively paying down the debt hurts our cash flow for our other goals.
Answer: It’s understandable that you don’t want to tap your savings or investments, since it’s difficult to build up those funds. But it really makes no sense to carry high-interest debt when the returns you’re getting on these other accounts are probably much lower.
Talk to your tax pro about the implications of selling some or all of your non-retirement investments, though. If your investments have gained substantially in value, you’ll want to factor in the tax bill or consider selling some of your money-losers instead.
Once the credit cards are paid off, some money that used to go to those payments will be freed up for other goals.
Your priority needs to be saving for retirement. Once you’re on track there, you probably should focus on rebuilding your emergency fund to equal at least three and preferably six months’ worth of expenses. You may not be able to accomplish that before your second child arrives, though, so consider opening a home equity line of credit as a proxy for a larger emergency fund. Leave the line of credit open and unused, however, because racking up a balance would defeat the purpose.
Saving for college is a worthy goal, although it shouldn’t take priority over retirement, paying off toxic debt or having an emergency fund. You may not be able to save enough to pay the whole bill, but you can shoot for saving one-third or half the expected cost, and your child can use federal student loans for the rest. SavingForCollege.com has a calculator to help fine-tune your plan. Even if you can’t save as much as you’d like, you should save something. Even $25 a month over time will help reduce the amount your child needs to borrow.
Home improvements should be last on your list of priorities, and you should try to pay for those with cash. They are not an investment in your home — although they may improve the value somewhat, you’ll typically get back less than 70% of what you spend.