Category: Business & Economy: Finance and Investment: Debt Advice
Reducing your debt and saving your money are unquestionably the two most important steps toward financial freedom. People often wonder which of these two strategies they should take on first – paying off the credit cards or hoarding money for the future. Since every dollar spent on one option means a dollar that can’t be spent on the other, the choice becomes a serious consideration with lasting consequences. The truth is, there is no right answer for everyone, and your unique financial needs will determine where your money belongs. Below are some tips to help you decide which of these important goals is more important for you right now.
Never Neglect Retirement Savings
When a person is juggling heavy debt, saving for retirement seems a far away goal with no immediate benefits. Without a sense of urgency, retirement savings often gets pushed to the side and ignored, while paying off debt becomes a top priority – after all, no one is calling your house day and night demanding that you save for the future.
MSN Money points out that this is a tempting, yet ultimately incorrect way to think, because the money you are neglecting to save now actually costs you money later in life. “Say your employer matches half of your 401k contributions up to 6% of your salary,” they explain. “If you make $40,000 but don’t contribute that 6%, you’re missing out on $1,200 of free employer money. Worse. If it earned an average 8% annual return over the years, that one year’s contributions could have grown to more than $35,000.”
How Secure Is Your Employment?
Financial experts often tell us that we should be saving a cash reserve equal to 6 – 8 months living expenses, but then we also hear that we should be prioritizing debt reduction above all else. How can we determine which to focus on first? The answer is to determine how secure you believe your employment is.
As Suze Orman from the Oprah show explains, “If you are in a situation where you are afraid that you’re going to lose your job, make it a big priority to create an 8 month emergency fund and pay the minimum on your cards. On the other hand, if you’re really secure in your job and you are paying high interest rates on your cards then you have to make it a number one priority to get out of credit card debt.”
Focus On High Interest Debt First
As you consider which debts/savings to attack first, keep in mind that if you have any credit cards with double-digit interest, you should focus on getting rid of them as quickly as possible. By allocating money to savings when your debt is accruing 25% interest, you may actually be losing money. This is because the cash sent to savings might end up being less than the amount the debt grows that month, and even though you feel better for having “saved” something, you have actually taken a net loss for the month.
On the other hand, if you have especially low interest rate on debt, and a high rate on your savings, you might be able to come out ahead by saving more money. MoneyMusings explains that, “If your credit is exemplary and your debt’s interest rates are low, say 2.99% or less, then debt paydown becomes much more of a case-by-case issue. You might be able to earn more (after taxes, even) by keeping your savings.” This is because if your debt only grows by, say, $50.00 in a month, but your savings could grow by $100.00, it makes sense to bias more money toward your savings, as you will ultimately earn more in the end.
Consider The Immediacy Of Savings Goals
Having “savings” is a commendable effort to be sure, what counts when deciding whether to save or pay debt is what the money is being saved for. For example, if your apartment lease is up in 8 months, and moving into a house is a priority for you and your spouse, it is urgently necessary that you begin aggressively saving toward that goal. Similarly, if your car has been experiencing mechanical issues and you feel it may be time to replace it, this constitutes another immediate goal that requires strong savings habits to attain.
Conversely, if you have no immediate goals and are just saving for savings sake, it makes more sense to use that money to eliminate debt. Far off desires (like a sailboat or a leisurely sports car) are good things to save for, but they are not urgently needed and can thus be put off in the name of eliminating your debts.
Balance Both With Scheduled Payments
When are put in the position of having to choose how to allocate your money, it will always feel like a better decision to save it. The fact is, it isn’t fun or rewarding to send your hard earned dollars to a credit card company just to reduce a number on a monthly statement. Luckily, online banking makes it possible to completely remove yourself from the process and turn your savings and debt payment as automatic as the paying of taxes.
Online banking is a standard part of most modern checking accounts, meaning if you have a bank account with any credible bank you are probably already signed up. By using it, you can set an automatic payment to your debts and an automatic contribution to your savings every month. By putting these obligations on auto-pilot, you never have the chance to hold your money and decide to keep it or send it away; it is simply taken care of every month without a second thought.