Question
Xavier has been working at his first post-college job for almost a year when his company gives him a raise, resulting in a paycheck increase of $200, for a total of $400 extra in take-home pay every month. He makes a quick list of possible ways to use that money, along with relevant notes for each.
What I can do...
Total cost or
outstanding balance
Interest rate
(when applicable)
Additional Notes
Save for fun summer vacation trip in 8 months
Estimated cost = $1000
1% - savings account
3 friends are going -- really want to join
Pay off credit card debt sooner
Balance = $6,500
20%
Completely up to date on payments
Typically pay monthly minimum only
Pay down student loan debt
Balance = $34,000
4%
Completely up to date on payments
Increase emergency fund
Balance = $250
1% - savings account
Realize this should be much higher
Have been lucky so far -- haven’t used the account once yet
Participate in company 401(k) plan
Not yet participating
Variable
Company will match dollar-for-dollar up to 5% of my salary ($250 a month)
Finance nicer, more reliable car
Estimated cost = $25,000
6%
Currently driving 14-year-old car paid for in cash at time of purchase
Would probably need to increase my auto insurance, too, to add better coverage
No down payment currently saved
Provide a detailed plan, including actual dollar amounts, for Xavier to wisely use the extra $400 per month from his raise. For each part of the plan, briefly describe why you’re making this choice.
What I can do...
Total cost or
outstanding balance
Interest rate
(when applicable)
Additional Notes
Save for fun summer vacation trip in 8 months
Estimated cost = $1000
1% - savings account
3 friends are going -- really want to join
Pay off credit card debt sooner
Balance = $6,500
20%
Completely up to date on payments
Typically pay monthly minimum only
Pay down student loan debt
Balance = $34,000
4%
Completely up to date on payments
Increase emergency fund
Balance = $250
1% - savings account
Realize this should be much higher
Have been lucky so far -- haven’t used the account once yet
Participate in company 401(k) plan
Not yet participating
Variable
Company will match dollar-for-dollar up to 5% of my salary ($250 a month)
Finance nicer, more reliable car
Estimated cost = $25,000
6%
Currently driving 14-year-old car paid for in cash at time of purchase
Would probably need to increase my auto insurance, too, to add better coverage
No down payment currently saved
Provide a detailed plan, including actual dollar amounts, for Xavier to wisely use the extra $400 per month from his raise. For each part of the plan, briefly describe why you’re making this choice.
Answers
GPT-4o mini
Xavier has several options for using his extra $400 per month, and developing a plan that balances his short-term and long-term financial needs is crucial. Below is a detailed plan tailored to Xavier's situation, including dollar amounts and reasoning for each decision:
### 1. Increase Emergency Fund
**Amount Allocated: $100/month**
- **Current Balance:** $250
- **Target Balance:** Ideally, aim for at least 3 to 6 months' worth of expenses.
- **Reasoning:** It’s essential to have a sufficient emergency fund to cover unexpected expenses. Since Xavier hasn't used his emergency fund yet, this is a good opportunity to build it up. Raising it by $100 per month will help him reach $1,000 in 10 months.
### 2. Pay Down Credit Card Debt
**Amount Allocated: $150/month**
- **Outstanding Balance:** $6,500
- **Interest Rate:** 20%
- **Reasoning:** Credit card debt carries a high-interest rate. By allocating $150 per month towards the balance, he can reduce the total debt faster and save on interest. This allocation will allow him to pay down his credit card balance significantly at about $1,800 in a year, which is an effective strategy given the high interest.
### 3. Contribute to 401(k) Plan
**Amount Allocated: $100/month**
- **Current Status:** Not yet participating
- **Company Match:** Dollar-for-dollar match up to 5% of salary ($250/month)
- **Reasoning:** Participating in the 401(k) plan is a wise long-term investment. Contributing $100 will allow Xavier to work towards the company match as he gradually increases his contributions. The match doubles his money up to the maximum, making this a smart use of his funds.
### 4. Save for Vacation
**Amount Allocated: $50/month**
- **Estimated Cost:** $1,000
- **Timeline:** 8 months
- **Reasoning:** A fun vacation is a great way to reward himself after a year of hard work. Saving $50 per month allows him to reach his $1,000 goal in 20 months. Although this means it will take longer than the vacation, it provides something enjoyable yet doesn't compromise his financial responsibilities.
### 5. Pay Down Student Loan Debt
**Amount Allocated: $0/month**
- **Outstanding Balance:** $34,000
- **Interest Rate:** 4%
- **Reasoning:** While it is important to address student loans, he has current financial priorities (credit card debt) with a higher interest rate. This makes them less urgent at this time. Once the credit card is paid off, any extra funds can be redirected toward this debt.
### Summary of Allocation
- **Emergency Fund:** $100
- **Credit Card Debt:** $150
- **401(k) Contributions:** $100
- **Vacation Saving:** $50
- **Student Loan Debt:** $0
### Total Monthly Allocation: $400
---
### Rationale
This allocation plan allows Xavier to:
1. **Build financial security** through an emergency fund.
2. **Eliminate high-interest debt** quickly by addressing credit card payments.
3. **Prepare for retirement** by starting to contribute to his 401(k) and capitalizing on employer matching funds.
4. **Enjoy short-term gratification** through planned savings for a vacation while still focusing on long-term financial goals.
In this way, Xavier balances immediate needs and future goals, setting him up for financial success without depriving himself of leisure.
### 1. Increase Emergency Fund
**Amount Allocated: $100/month**
- **Current Balance:** $250
- **Target Balance:** Ideally, aim for at least 3 to 6 months' worth of expenses.
- **Reasoning:** It’s essential to have a sufficient emergency fund to cover unexpected expenses. Since Xavier hasn't used his emergency fund yet, this is a good opportunity to build it up. Raising it by $100 per month will help him reach $1,000 in 10 months.
### 2. Pay Down Credit Card Debt
**Amount Allocated: $150/month**
- **Outstanding Balance:** $6,500
- **Interest Rate:** 20%
- **Reasoning:** Credit card debt carries a high-interest rate. By allocating $150 per month towards the balance, he can reduce the total debt faster and save on interest. This allocation will allow him to pay down his credit card balance significantly at about $1,800 in a year, which is an effective strategy given the high interest.
### 3. Contribute to 401(k) Plan
**Amount Allocated: $100/month**
- **Current Status:** Not yet participating
- **Company Match:** Dollar-for-dollar match up to 5% of salary ($250/month)
- **Reasoning:** Participating in the 401(k) plan is a wise long-term investment. Contributing $100 will allow Xavier to work towards the company match as he gradually increases his contributions. The match doubles his money up to the maximum, making this a smart use of his funds.
### 4. Save for Vacation
**Amount Allocated: $50/month**
- **Estimated Cost:** $1,000
- **Timeline:** 8 months
- **Reasoning:** A fun vacation is a great way to reward himself after a year of hard work. Saving $50 per month allows him to reach his $1,000 goal in 20 months. Although this means it will take longer than the vacation, it provides something enjoyable yet doesn't compromise his financial responsibilities.
### 5. Pay Down Student Loan Debt
**Amount Allocated: $0/month**
- **Outstanding Balance:** $34,000
- **Interest Rate:** 4%
- **Reasoning:** While it is important to address student loans, he has current financial priorities (credit card debt) with a higher interest rate. This makes them less urgent at this time. Once the credit card is paid off, any extra funds can be redirected toward this debt.
### Summary of Allocation
- **Emergency Fund:** $100
- **Credit Card Debt:** $150
- **401(k) Contributions:** $100
- **Vacation Saving:** $50
- **Student Loan Debt:** $0
### Total Monthly Allocation: $400
---
### Rationale
This allocation plan allows Xavier to:
1. **Build financial security** through an emergency fund.
2. **Eliminate high-interest debt** quickly by addressing credit card payments.
3. **Prepare for retirement** by starting to contribute to his 401(k) and capitalizing on employer matching funds.
4. **Enjoy short-term gratification** through planned savings for a vacation while still focusing on long-term financial goals.
In this way, Xavier balances immediate needs and future goals, setting him up for financial success without depriving himself of leisure.