In today’s America, there are quite a few cities where even a six-figure salary can leave you feeling broke.
According to a recent study from LendingTree, in 25 of America’s 100 largest metros, a family of three would need more than a combined $100,000 income to meet basic expenses each month [1]. For example, a family in San Jose with a household income of $100,000 a year would still face a shortfall of $2,207 every month after covering their basic expenses.
Katie and Brad are just two of the many Americans who find themselves in this tough situation. The couple, both 32 years old, earn a combined $170,000 per year while raising their two children in San Francisco — where a family of three that earns more than $100,000 per year is likely to face a $1,804 shortfall every month.
Between their rent ($2,500 per month), childcare costs and about $30,000 in combined student loan and credit card debt, Katie and Brad are finding it hard to see beyond the monthly expenses and put money away for their future.
Right now they have about $50,000 saved for retirement, but in order to get ahead of their debt, they’ve stopped contributing regularly to their 401(k)s. Meanwhile, the spiralling costs of essentials have also wiped out their emergency fund.
Despite these financial challenges, their goal is to save for a down payment on a home and contribute at least 15% of their income each month to their retirement accounts. With this in mind, here are some tips for Katie and Brad — or anyone else who is paid well yet still struggles to get ahead.
Despite the fact that they’ve chosen to focus on their debt, couples that are in Katie and Brad’s shoes often wonder about what to work on first: paying down the debt, or prioritizing retirement savings.
Turns out Katie and Brad wisely chose debt.
While there are multiple schools of thought on which approach is best, one effective way that Katie and Brad could tackle their financial predicament is with Dave Ramsey’s 7 Baby Steps [2]. According to this approach, Katie and Brad should do the following, in order:
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Save $1,000 in an emergency fund, which they can build on later
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Use the debt snowball method to pay down their $30,000 student loan and credit card debt
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Try to add at least three months’ worth of expenses to their emergency fund
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Begin investing at least 15% of their household income in retirement savings
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Set aside funds for their children’s education
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Start saving for a down payment — for existing homeowners, Ramsey recommends paying off the mortgage early
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Build wealth and give back: Debt-free and living in their own home, Katie and Brad can then look to build wealth and/or give back to charitable causes
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With this approach, Katie and Brad can get an emergency fund established while chipping away at their debt. Once the debt is settled, the couple can then turn their attention to beefing up their emergency fund and allocating a portion of their monthly income to retirement savings. After that, they can focus on setting money aside for a downpayment.
Here’s how Katie and Brad can put their first few baby steps into action.
Read more: Rich, young Americans are ditching stocks — here are the alternative assets they’re banking on instead
Before Katie and Brad start working on the first of their baby steps, it’s important for the couple to understand where their money goes each month and create a budget that leaves money for savings or paying off debt.
To establish a solid budget, Katie and Brad can start by gathering a year’s worth of bank statements — including credit cards and any investment accounts — so that they can understand how they spend their money.
This can help them to create a budget that’s based in reality, rather than vague notions of how they think they spend, or where they think they can cut down on spending.
While advice on how much to save in an emergency fund largely depends on your personal situation, most personal finance experts suggest anywhere from three to six months’ worth of expenses.
According to Ramsey [4], you should opt to save three months’ worth of expenses if:
On the other hand, six months’ worth of expenses is safer if:
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You’re married and live on one spouse’s income
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You’re in a seasonal job, self-employed, work on commission or in a volatile industry
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You’re a single parent
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You have dependents who are chronically ill
Once their debts are paid off, Katie and Brad can use the momentum from the debt snowball method to find the funds to stash away in their retirement accounts.
The debt snowball method requires you to first tackle your smallest debt, while making minimum payments on all other debt. Once the first debt is fully paid, the money used for that monthly payment is applied to the next largest debt, and so on, until all debts are cleared.
That money can then be used to beef up Katie and Brad’s emergency fund. Once they have cleared their debts and fully replenished their emergency savings, they can then redirect that money to their 401(k)s or any other retirement accounts they may have.
Thankfully, Katie and Brad are still young and may both work for another 35 to 40 years before they retire. With this in mind, they have a long time to save and get back on track with their retirement savings targets. However, to take advantage of the benefits of compound interest, Katie and Brad should strive to pay down the debts and beef up their savings as soon as they can.
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[1]. LendingTree. “The 25 US Metros Where a Family of 3 Can Make 6 Figures and Still Be Broke”
[2]. Ramsey Solutions. “The Seven Baby Steps”
[3]. Credit Counselling Society. “Budget Breakdown for Monthly Costs”
[4]. Ramsey Solutions. “Emergency Fund: Why You Need One and How Much to Save”
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