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Top Priorities?

AS WE TRY to figure out how to invest our savings, we need to tackle two separate—but closely connected—questions. First, why are we investing? We might be aiming to save for retirement, build up an emergency fund, pay down debt, fund a child’s college education or amass enough for a house down payment.

Second, what are our most attractive investment opportunities? We know what interest rate we can avoid by paying down debt. We can also be reasonably confident that, over a 10-year holding period, a diversified stock portfolio will outpace bonds, which—in turn—should fare better than cash investments. But we also need to consider other factors, such as the tax advantages of funding retirement plans, as well as any matching employer contribution to our 401(k), 403(b) or health savings account.

Some experts contend we shouldn’t do anything with our money until we’ve built up an emergency fund equal to three-to-six months of living expenses. That typically means stashing dollars in cash investments held in a regular taxable account, so we’re looking at both modest investment gains and no special tax advantages. An appealing alternative: Fund a Roth IRA. At any time, we can pull out our original contributions to a Roth IRA—but not the account’s investment earnings—with no taxes or penalties owed.

Meanwhile, other experts argue that our top priority should be funding either our employer’s 401(k) plan or a health savings account (HSA), and perhaps both. Why? These accounts offer great tax advantages and the opportunity to invest in the stock market, plus our savings may garner a matching employer contribution. On top of that, retirement is our most expensive goal. Indeed, accumulating enough for a comfortable retirement often takes at least three decades of diligent saving. And, yes, an HSA can be used to pay for retirement.

Got both retirement and financial emergencies covered? Our next priority might be paying off high-cost debt, notably credit card debt. That will give us a rate of return equal to the interest rate charged. After that, we might look into funding either a tax-deductible or Roth IRA, assuming we’re eligible.

While paying down high-cost debt and funding an IRA might make sense in terms of investment returns, these might not be the right choices if we have other goals. For instance, if our top priority is buying a home, we should probably sock away money in a savings account or a money market fund held in a regular taxable account (though, again, we could fund a Roth IRA and look to pull out our original contributions, or even stash dollars in a 401(k) and plan to take out a loan). Similarly, if paying for our children’s college costs is a top priority, we might fund a 529 college savings plan, which could give us tax-free growth and perhaps a state tax break.

Next: What Savings Rate?

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