I give subscribers to the Gen Y Wealth Newsletter a chance to ask me a question or two about personal finance. The purpose of this for me is to find specifically what’s on people’s mind financially.
A few weeks ago, I received a question from a female reader, let’s call her Arwen (Liv Tyler’s character in Lord of the Rings which I watched last night) in a situation that’s very common among members of Gen Y. Knowing that I have gotten a few questions like this in the past, I thought I could expand on my answer in a post.
Here is Arwen’s email:
- I have about 30K in student loans to repay – how can I pay them back while still saving for other goals?
- I just got hired making about $30K a year and I’m eligible for benefits and 401(K) in 90 days…how do I choose what’s right for me?
- I’d really like to travel, but my savings is currently devoted to staying just that: savings. My savings account is my emergency fund and I’ve built up about $1K to act as a cushion. How can I still save up for a trip while paying for loans, rent, utilities, incidentals, groceries, retirement, etc.?
Basically, I’m looking for a post on financial balance. How can a typical college grad best allocate my income? Should I devote more of my money to paying off the loans early or should I look toward retirement? Should I look into loan consolidation? Where do I even begin when those 90 days is up and I have to choose a 401(K) plan?
Find the Balance with Focus
The biggest dilemma facing Arwen right now is how to allocate her income. Should she pay the minimum on her student loans and invest for retirement? Should she pay off the student loans and wait to invest for retirement? Or, should she pay the minimum on student loans, invest some, and use the rest to save for some short-term goals? Plus, which one of these options provides for the best “financial balance.”
While my answer is probably not what Arwen wants to hear it’s what I believe the best solution is for her. That is, that right now, being 30K in debt, it’s not time to think about financial balance. Instead, Arwen needs to think about financial focus.
30K is a lot of money to be in debt. The magic of compound interest is either works against you or for you. In Arwen’s case, it’s working against her.
Here’s how I would allocate my income if I were in Arwen’s situation.
If my student debt had a higher interest rate than 6%, I would pay that off in full before investing for retirement. Even if my employer matched my 401(k) contributions.
If my student debt was below 6% and my employer matched my 401(k) contributions, I would contribute to get the maximum match and then work to pay off my student loans in full with the remaining income.
If my employer doesn’t offer a 401(k) match and my student loans were below 6%, then I would focus on just one thing. I would either invest as much as I can in a Roth IRA, if early retirement was my goal, because its withdrawals rules are more flexible then a 401(k), or use all of my income to pay off my student loans. Personally, I would avoid doing both because very little will actually be accomplished.
What to Do With Benefits
As far as benefits in Arwen’s situations, I wouldn’t go without health insurance. It’s expensive but just one broken bone or sickness can rack up more than 10K in debt fast.
If she isn’t already, Arwen should get on a health insurance plan for the next 90 days. If she is under 26 (even higher in some states), she can join her parents plan as a dependent. Another option is extending the student insurance she had in college. If all those fail, Arwen should get on a high deductible health plan for the next three months. A policy like this can be had for around $100 a month and is well worth the protection.
In 90 days, when the time comes to select a health insurance plan, Arwen should evaluate all of the company’s options and her own health history. Assuming she maintains a healthy lifestyle and only goes to the doctor once or twice a year for wellness checkups, the cheapest health insurance plan might save her the most money. If Arwen is on a few prescriptions and has gone to the doctor frequently in the past, maybe the more expensive plan will cost her the least in the long run.
What about Other Goals?
Like many other young adults, Arwen’s wants to travel. Unfortunately for Arwen, right now there isn’t a lot of money left to save for other goals.
That doesn’t necessarily mean that money she can’t earn more, in the near future. As Benjamin Franklin once said, “”There are two ways to increase your wealth. Increase your means or decrease your wants. The best way is to do both at the same time.
To increase Arwen’s means, she should look to see how she at ways to make more money. Depending on what Arwen’s skills are, she should look for extra opportunity to earn income.
Last, I would tell Arwen that the lack of money doesn’t mean she can’t travel. Maybe, instead of traveling abroad to Europe, the best option for now might be taking a camping trip. What about taking a road trip and sleeping on friend’s couches? There are always options, if you think creatively.
What advice do you have to offer to Arwen? What would you do if you were in her situation?
Photo by: Jenifercw