As you might expect, there’s no black-and-white answer to this question, but I advise my clients to follow these steps:
There aren’t many times when taking on debt makes more sense than using your savings, but one I can think of is buying a new house. I see many of my clients buying a new house before selling their original house, and they ask me if they should sell their investments to pay for the new house. My answer is no; utilize the low rates that come with a mortgage and don’t sell your investments to cover the down payment unless you need to. You can later use the cash proceeds from the sale of your original house to start paying off the mortgage and increasing your cash account.
Some clients have asked me if debt with low or no interest should be addressed later in favor of investing, and the answer really depends on what kind of debt it is. You may have a credit card that has low interest now, but that interest could quickly increase if you don’t pay off the debt. In this situation, it’s best to pay off the credit card debt as soon as you can. But if your car or mortgage payments have low interest, it might make more sense to invest your money and pay off those expenses over a longer period.
Back to the emergency fund: Many of my clients wonder how much of their investments should be kept liquid and how they can calculate this amount. When evaluating how much money you might need in an emergency, it’s important to analyze what “could” happen. We define spending shocks as events you’ll have to pay for, no matter what—such as home or car repairs. An income shock—such as getting laid off—can pack a heavier punch. I ask my clients to evaluate the risks of each type of shock:
Thinking about these situations can be stressful but will allow you to evaluate how much money you’d need in an emergency.
If you’re lucky enough to be without any debt, save as much as you can as early as you can; it will always pay off in the long run. Review your budget frequently—especially as you enter retirement, since your budget will change completely—and assess where you can cut costs and how you can readjust your habits. Do this as frequently as you can and you’ll always know where your money is going.
All investing is subject to risk, including the possible loss of the money you invest.
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