Prioritize Your Cash Flow for Maximum Retirement Savings

By Robert Rapier • July 30, 2024 • Stocks to Watch

Last week a member of one of my Facebook groups posed this scenario:

“I’m about to increase my salary by $40k (putting me over $200k annually) and unsure of how I should allocate it. My house is currently 41% of my net (selling it is not an option) and my car debt is minor. I have approximately $16k on credit cards, student loans of $20k, and a 401(k) loan. I’m slowly rebuilding my emergency fund, but no other savings beyond my employer match in my 401(k). I’m 43 and have been telling myself that I’ll be retired by 50, but it’s not looking so hot.”

Handling Debt

This person is facing one of the challenges inherent in building wealth: Where to allocate your money. I dealt with this kind of scenario in A Dozen Steps for Building Long-Term Wealth. On the topic of debt, I wrote:
“Minimize high-interest debt, such as credit card debt, as it can hinder wealth-building efforts. Prioritize debt repayment, starting with high-interest debts, while ensuring you’re making regular payments on other debts.”
As I have said many times, the long-term average annual return of the S&P 500 is around 10%. It doesn’t make sense to put money away in investments if you have debt with interest rates exceeding this. Plus, you are paying this debt with after-tax dollars, so you should probably prioritize paying down any debt with interest rates exceeding 8% before allocating money to the stock market.
In this person’s situation, there is one exception. You should always take advantage of an employer’s match in a 401(k), because in nearly all circumstances it will be an immediate return well beyond 10%. Often, it will be a one-time return of 50% or 100% of the money you put away, up to a limit.
With that said, here is how I would advise this person.

Specific Advice

First, focus on rebuilding the emergency fund until it can cover 3-6 months of living expenses. This fund provides a crucial safety net for unexpected expenses or job loss, ensuring peace of mind and financial stability. Prioritizing this step will help you handle emergencies without relying on high-interest debt.

At the same time, prioritize paying off high-interest debt, particularly the $16,000 in credit card debt. Focus on paying off the highest interest rate debt first. This approach will rapidly reduce the amount of interest you pay, freeing up more money to pay down the debt.

Consider trading down to a cheaper car to help pay down debt. Once you’ve tackled the high-interest debt, shift your focus to paying down the $20,000 in student loans and the 401(k) loan. Although these typically have lower interest rates, reducing your overall debt burden is crucial for financial health. Paying off these loans will free up more income for savings and investments.

In terms of retirement savings, you need to start saving beyond the employer match. Aim to contribute 15-20% of your income, especially with the goal to retire by 50. This increased contribution will help ensure you have sufficient funds to support yourself in retirement.

After addressing your debts and ensuring adequate retirement contributions, diversify your savings by investing in vehicles like a Roth IRA or brokerage accounts. These investments offer growth potential and help build a more robust financial portfolio.

Regularly review and adjust your budget to ensure you’re living within your means and allocating funds appropriately toward your financial goals. Monitoring your spending and making necessary adjustments can help you stay on track and maximize your increased salary.

By following these steps, you can make the most of your increased salary, reduce your debt, and move closer to your financial and retirement goals.

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Robert Rapier is an income investing legend. He’s the chief investment strategist of Utility Forecaster, Income Forecaster, and Rapier’s Income Accelerator.

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