Laura Rowley Money & Happiness

For most people, saving and paying off debt is a juggle. A recent survey found that in the face of the economic crisis, many Americans are boosting their rainy-day funds and chipping away at their credit card balances.

But when you've got limited dollars, high-interest debt to pay off, and competing savings goals like retirement and college, where do you put your extra cash first?

Climbing the Savings Ladder

Charles Schwab recently began promoting an eight-step "Savings Fundamentals" plan to help consumers prioritize their objectives. The company recommends that everyone climb the first four rungs of the ladder, then navigate the last four based on personal priorities. Here's the order:

1. Contribute to your company's retirement plan at least up to the amount of any match offered.

2. Pay off non-deductible, high-interest debt, such as credit cards.

3. Create an emergency fund with three months' worth of living expenses (keep in a savings account).

4. Max out the rest of your 401(k) contributions.

5. Save for a child's education (in a 529 savings plan or Coverdell account).

6. Save for a home down payment.

7. Pay down tax-deductible, high-interest-rate debt like mortgages, home equity loans, and student loans.

8. Keep investing.

Up the Ladder Backwards

These priorities are based on activities that offer the highest potential interest rate return on the money, says Dean Kohmann, Schwab's vice president of 401(k) plan services. "Almost 90 percent of companies offer a match in their retirement plans, typically 50 cents on the dollar up to 6 percent," he says. "That's an immediate 50 percent return on investment."

After funding their 401(k), savers should tackle credit cards, with average interest rates somewhere around 15 percent, and other non-deductible, high-interest debt; then seed an emergency fund to avoid falling into credit card debt again.

The rub, of course, is that most people don't think of money on purely objective terms: A recent survey by Schwab found consumers' top priority is paying off credit cards, followed by building an emergency fund. Funding a retirement plan up to the match ranked third, followed by paying off mortgages and other deductible debt.

A Matter of Perspective

The behavioral part is an important aspect of finance," says Diahann Lassus, founder of the financial planning firm Lassus Wherley & Associates PC in New Jersey, and chairperson of the National Association of Personal Financial Advisors.

"If [building] an emergency fund while continuing to make payments on credit cards gives you comfort that you don't have to be adding to your debt, and helps you sleep at night, that's fine," Lassus says. "Some people believe carrying mortgage debt forever is OK; for others, it makes them crazy. So it is absolutely based on the way I see the world and what's important to me."

College-Bound Savings

For instance, what's most important to parents in Schwab's survey is college: Saving for this expense ranked second for the demographic after paying off credit cards. Schwab puts saving for college fifth on its list -- after maxing out the rest of one's retirement contributions.

Mark Kantrowitz, founder of the college planning website Finaid.org, agrees that families should focus on maximizing their overall after-tax return on investment. But that may still put funding a state-sponsored 529 plan in the top four priorities.

"While a 401(k) match likely provides the highest return, further retirement savings might not yield the best return on investment," he wrote me in an email. "For example, 32 states offer a full or partial deduction on the state income tax return for your contributions to the state 529 plan, effectively giving you a small match on those funds." A few caveats: Minimize fees by choosing direct-sold plans (rather than broker-sold) that charge less than 1 percent on top of the underlying mutual funds' expenses, he advises.

The Golden Age of Saving

Moreover, day-to-day economic realities should influence priorities -- someone whose job is in jeopardy may want to stop contributing to their 401(k) and boost emergency savings to six months' worth of living expenses, Lassus says.

Political realities affect the wisdom of financial advice, too. Retirement savings may need to be a higher priority for people in their 20s than those in their 50s, Lassus adds.

"It does become more of a concern for young people than for older people, who at least think they're guaranteed to have Social Security when they retire," Lassus says. "You can make a case that it makes sense for younger people to make retirement savings a top priority, because the earlier you put the money in the more it builds over time. They typically don't have a pension to fall back on, and who knows what's going to happen in 40 years with Social Security."

Making Hay

That's how 25-year-old Malea Barron feels. A Dave Ramsey fan, the Nashville public relations executive is debt-free and has been maxing out her Roth IRA contributions since 2005. She's not yet eligible to contribute to her company's 401(k) plan, but intends to max it out when she can. She also puts $200 a month away in an emergency fund.

"I'm thinking even if I retire at 65, I'm not going to have the Social Security benefits that the elderly do now," says Barron. "I want to be progressive and be able to live comfortably when I'm 65."

Barron says her parents, auto factory workers who never attended college, impressed on her the importance of getting an education, staying debt-free, and saving from the time she was a teenager. They sold their suburban house and bought a 100-acre farm an hour south of Nashville in their early 50s; both still work full-time.

"They built their dream home and are completely debt-free -- it was quite a transformation," she says. "I have the ability to [save for retirement] now while I'm single. Once I purchase a home or get married or have kids, my priorities will probably change. Right now it's just me, and I should take care of me while it's just me."

Your Psychology Today

Clearly, putting financial priorities in a rational economic order will increase the rate of return on your money and lower the cost of debt. But there may be a psychological toll from making decisions on a purely economic basis, according to a study of savers by Peter Lunt and Sonia Livingstone published in the Journal of Economic Psychology.

"Those who kept their savings rather than using them to pay debts ... had a greater feeling of control over their circumstances," the authors write. "Similarly, those who save up out of their income at the same time as paying off debts (rather, say, than paying off their debts faster) felt more in control of their finances and more optimistic about their future than those who did or could not save while having debts."

Kohmann says those kinds of studies underscore the need to prioritize financial behavior in a rational way. "The psychology of it does not make sense and will not work out better in the end financially," he says. "Hopefully people will take a look at fundamentals, think twice about their behavior, and change their psychology to what makes objective sense as well."