Your money priorities, first to last

By Liz Pulliam Weston

Here's a money secret that might keep you from driving yourself crazy: You can't do it all.

We're supposed to max out our retirement savings, pile up huge emergency funds, pay off all our debts and buy tons of insurance. Yet we've also got other bills to pay, kids to raise and, yes, fun to have.

Even in good times, many of us can't cover all the bases perfectly. Now that many are facing pay cuts, unemployment or unpaid furloughs, more of us are facing painful trade-offs on less income.

Here's what you need to know now to properly prioritize your spending and manage your money. You may not be able to cover everything right away, but as more money comes in you can work your way down the list and be reasonably sure you're getting the important stuff right.

Priority No. 1: Pay your bills

Obviously, you need to keep a roof over your head and food in the fridge. But your ability to manage all your other financial priorities will be greatly enhanced if you can get a handle on your basic living expenses.

Bankruptcy expert Elizabeth Warren recommends limiting your "must-have" bills to 50% of your after-tax income. Must-haves, as she wrote in "All Your Worth" (co-written by her daughter Amelia Warren Tyagi), include shelter, utilities, transportation, food, insurance, child care and minimum loan payments.

Her plan leaves 30% for "wants" such as new clothes, entertainment and vacations, and 20% for savings and debt repayment.

If your must-haves balloon over 50% of your after-tax pay, you may be able to rein in your costs by trimming your food bills and lowering your home's thermostat. If not, you may have to make more painful adjustments, such as finding a cheaper place to live or getting rid of a too-expensive car.

What you shouldn't do is cut your insurance coverage. Shopping around for coverage and choosing higher deductibles are better ways to lower costs than dropping your policies altogether, since that can leave you exposed to catastrophic expenses from accidents, illness or lawsuits. What you need:

• If you have a car, you need liability coverage, at least. Comprehensive and collision insurance is a good idea on newer cars and may be required by your lender.

• If you own a home, homeowners insurance is essential. Make sure you have enough coverage to rebuild your home, plus adequate liability insurance ($500,000 is good, and more is better).

• If you rent, renters coverage is a smart buy. Your landlord's policy doesn't cover your stuff or your liability.

• Health insurance is a basic expense you shouldn't forgo if you have any choice, because a single accident or illness can bankrupt you. If you don't have or can't afford coverage, read "A survival guide for the uninsured."

• Life insurance may be an essential, but only if you have financial dependents (people who need your income to survive). Term insurance is the cheapest way to go; learn more at MSN Money's Save on Life Insurance Decision Center.

If your income isn't stretching far enough to cover your must-have bills, read "How not to pay your bills" and consider a consultation with a bankruptcy attorney. For more on bankruptcy, visit MSN Money's "Guide to Personal Bankruptcy."

Priority No.2: Save $500

Just a few hundred bucks in the bank can eliminate expensive bounced-check and late-payment fees. Having $500 in the bank also allows you to pay for minor emergencies without adding to your credit card debt. Furthermore, there's a huge psychological advantage to having even this small cushion, as I wrote in "Want to sleep better? Save $500."

Eventually, you'll want a bigger stash to guard against financial setbacks, but $500 is a good initial goal. Set up an automatic transfer from your checking account into a high-yield savings account, or jump-start your savings with a windfall, such as your tax refund check.

Priority No. 3: Start saving for retirement

You may be surprised to see retirement so high on the list. Surely your credit card debt and your kids' college educations are more important.

Except they're not. You have only so many working years to set aside enough cash to last you for the rest of your life, and any delay in getting started will cost you big time. Waiting just five years to begin can reduce your total nest egg by as much as 30%.

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Stopping or reducing your contributions is another bad move. It may be hard to contribute when markets are so volatile, but it's still important if you hope to build a nest egg. (Read "Under 35? Hurray for the meltdown" for more.)

But how much should you save? In "16 favorite money rules of thumb," I suggested that you save "10% for basics, 15% for comfort, 20% to escape." If you start saving for retirement by your early 30s, putting aside 10% of your income should cover your basic expenses in retirement, while a 15% contribution rate should give you a more comfortable nest egg. A 20% rate should allow you to retire early or enjoy luxuries such as extensive travel.

Continued: What if you can't manage 10%?

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