Lisa Whitley— I recently asked a good friend what personal finance question was top of her mind these days. Her response was one that sounded pretty familiar:
“If I am behind on saving for retirement, should that be my first priority? Or should I prioritize a larger emergency savings fund?”
In general, questions about how to balance equally compelling priorities are probably the most common...and the trickiest to answer. The answer is almost always “it depends.” Here is a hopefully useful approach to this particular conundrum:
- If your situation is not stable — you have faced a job loss or significant drop in income, or expect that this is on the horizon — then your first priority must be building up your cash cushion. If you are still employed and making regular contributions to your retirement account, stop.
- If your situation is stable, but the balance in your emergency fund is minimal or non-existent, priority one should be getting that account up to a level at least equal to one month of expenses, even if this means shutting down your retirement contribution for a time.
Then, having accomplished that first milestone, turn on your retirement contribution again, but only up to the employer match percentage until you have achieved your next milestone — an emergency fund equal to at least 3 months of expenses. That said, for many people, 6 months (or more) is the new 3 months; even if you feel stable now, you will want to think very creatively about how you and your family may be impacted by a prolonged economic downturn. Once you have hit your emergency fund target, then you can fully turn your attention back to your retirement account and increase your contribution.
- Finally, if your situation is stable and you have an emergency fund in place that is well-suited to your needs, then by all means make retirement savings your first priority.