In the past few years, Americans have done a pretty good job of whittling down their debt load. If you’re in this group, you may now have a chance to use your lower level of indebtedness to your advantage — by investing for the future.
Consider the numbers: In 2007, just before the financial crisis, the country’s household debt service ratio was about 14 percent (the debt service ratio is the ratio of debt payments, including mortgages and consumer debt, to disposable personal income). But by 2012, this figure had dipped below 11 percent, the lowest level since 1994.
These figures are national averages, but they do translate into real-life savings for many of us. If you’re in this group — that is, if you’ve lowered your debt payments noticeably — what should you do with this “found” money?
Of course, you could spend it on material objects, which, in some cases, may make your life more pleasant today. But you’d probably be better off by devoting your financial resources to your goals for tomorrow, such as college for your children and, eventually, a comfortable retirement lifestyle for yourself.
Consequently, you may want to consider these suggestions:
• Increase your contributions to your retirement plan. Try to put more money into your employer-sponsored retirement plan, such as a 401(k), 403(b) or 457(b). Your contributions are typically made with pretax dollars, so the more you invest, the lower your taxable income. Plus, your earnings can grow on a tax-deferred basis.
• Fully fund your IRA. You can put in up to $5,000 per year (as of 2012) to a traditional or Roth IRA, or $6,000 if you’re 50 or older. A traditional IRA grows tax-deferred, while a Roth IRA can grow tax-free, provided you meet certain conditions.
• Fill in “gaps” in your financial strategy. With a little extra money each month, can you find ways to fill in the “gaps” in your financial strategy? For example, do you have sufficient life insurance and disability income insurance? Or can you add some investments that can help diversify your overall portfolio? While diversification can’t guarantee profits or protect against loss, it can help reduce the effects of volatility on your holdings.
• Build an emergency fund. It’s a good idea to build an emergency fund containing six to 12 months’ worth of living expenses. Without such a fund, you may be forced to dip into long-term investments to pay for unexpected costs, such as a large bill from the doctor or a major car repair. Keep the money in a liquid, low-risk account.
• Establish a 529 plan. If you have children or grandchildren whom you would like to help get through college, you might want to contribute to a 529 plan. Your earnings grow tax-free, provided withdrawals are used for qualified higher education expenses. Plus, your contributions may be deductible from your state taxes (be aware, though, that withdrawals used for purposes other than qualified education expenses may be subject to federal and state taxes, plus a 10 percent penalty).
Reducing your debt level can remove some stress from your life. And you’ll gain even more benefits from debt reduction by using your savings to speed your progress toward your important financial goals.
• This article was written by Edward Jones for use by Ahwatukee Foothills Edward Jones Financial Advisor Joseph B. Ortiz, AAMS, CRPS. Reach him at (480) 753-7664 or firstname.lastname@example.org. Accredited Asset Management Specialist and AAMS, Chartered Retirement Plans Specialist and CRPS are registered service marks of the College for Financial Planning.