One of the biggest areas we help young families with is prioritizing how to put each dollar you earn to work. Paying down debt and saving for retirement are usually high on the list of priorities.

Here is the thought process we walk families through:

Prioritize Paying Down High Interest Debt

Typically, high interest credit card debt should be prioritized over retirement savings. The key factor is whether your retirement savings can out-earn the interest rate you are paying on the debt.

With the high rates on most credit cards, it’s very unlikely you’ll earn more in the stock market than the interest you are avoiding by making additional payments on a credit card balance.

The one exception is if you have an employer retirement plan, like a 401(k) or 403(b), where your employer matches a portion of your contributions. This type of matching contribution is additional compensation that you’d otherwise be missing out on.

In this case, contribute enough to get the full employer match, then start to tackle your high interest debt.

Think About Emergency Savings

One piece of this prioritization puzzle that is often overlooked is building up an emergency fund. After paying down your high interest debt, make sure you have 3-6 months of expenses saved and easily accessible.

There’s no sense in stashing savings into a retirement account only to have to pull it out and pay penalties to cover unexpected expenses.

Focus on Retirement Savings

Prioritize retirement savings over making extra payments on lower rate auto loans, student loans, or a mortgage. When invested properly, the compounded growth on your retirement savings should outweigh the interest you pay on the debt over the long term.

If you have debt with an interest rate greater than 5-6%, that’s when it makes sense to stop and think about how to allocate your extra cash. And if you’re struggling to decide the best course of action, put some money toward retirement savings and some toward paying down the debt.

A Note About Mortgages

Young families should be particularly careful about prepaying a mortgage before saving for retirement or other financial goals. You’re not only paying down low interest debt, but also putting your money into an illiquid asset that has historically earned less than the stock market.

Final Thoughts

Everyone’s situation is different, but this gives you a place to start when prioritizing how to put your money to work. As with most things when it comes to financial planning, the most important part is to be intentional and thoughtful about your decisions.

Click here to download our free guide: 5 Financial Mistakes Made by Young Families and How to Avoid Them

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.