Cards, Retirement, Or Emergency Fund?

Today, I was reading an MSN Money article by Liz Pulliam Weston where she recommended setting priorities in the order of retirement, then credit cards, then emergency fund. Personally, I rank them small emergency fund, credit card debt, retirement, bigger emergency fund. One of my astute readers pointed out to me that Suze Orman takes yet another tack: credit cards, then emergency fund, then retirement.

With three completely different priority lists, how does someone know which one is the right one to take? This made me think about the reasons behind the difference in order.

First of all, all of these philosophies agree on the most important point: spend less than you make. This is really the first step, and everything else follows from that. If you’re having trouble doing that, cut some fat out of your budget, even if it seems hard. If you can’t consistently spend less than you make, you’re in trouble and something has to change.

Given that, there are two questions that you can answer that will help you figure out your priority list and it should illustrate why Liz and Suze and myself have different ideas on what is the biggest priority.

First, how likely are you to have a significant crisis in the next few months? A car breakdown, a job loss, or a medical issue, for example. The higher the likelihood of such an event, the more important an emergency fund becomes. This means that if you’re married, a fund becomes more important – the same is true for children and for owning a home. What’s the “right” answer here? There is none – it’s actually all about one’s life experiences. It’s impossible to predict the short-term future of someone’s life like that, so in order to advise a priority list, you have to use your own experiences to decide how important an emergency fund is. Looking at the list, it’s clear I think that emergencies are more likely than Suze, while Suze feels they’re more likely than Liz.

Next, how likely are you to run up more credit card debt? I usually believe that when people come around to their financial apocalypse, they become very scared of debt – I know I was – and thus they have no interest at all in running up credit card debt. Liz, on the other hand, assumes that her readers are much more likely to run up additional credit card bills in the next few months. The more likely you are to keep charging, the less vital paying off your credit cards now becomes. Why? Paying them off now means you’ll have lots of available credit, and if you’re prone to charging a lot, it’s like throwing good money after bad. Suze and I are both less likely to think you’ll run up more credit card debt than Liz is.

As a general rule of thumb, the more diligent you are about your finances, the more important it is to eliminate high interest credit card debt immediately. That was the first thing I did after my financial apocalypse and I haven’t run up any revolving debt since, but if I hadn’t stayed off the credit cards, it would have been a waste of my time. Also, an emergency fund’s importance directly relates to how you live your life. If you’re more likely to have a crisis (if you have a home, if you have kids, etc.), then an emergency fund becomes more important.

It’s really interesting to look at how personal finance advice can change depending on who you’re talking to. It truly is personal.

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