Saving vs. Paying Down Debt
“Should I be saving for retirement or paying down debt? I just don’t know what to do.”
This is a question/reaction that we receive often from prospects or new clients. It’s a tough question to answer because everyone is different and there are a multitude of factors that play a role in how to answer that question (age, interest, cash balance, goals, etc.). In general, we believe that savings vs. paying down debt is a balancing act. We don’t want to forego the compound interest that we could have received because we waited to save while we pay down our debts. But we also don’t want high paying debts to accrue interest for longer than needed because we were focused on savings. Below are a few things to consider that may help you navigate when faced with the question, “Should I be saving or should I be paying down debt”
Do I have an emergency bucket?
An emergency bucket is a cash balance that reflects a portion of your living expenses that you can live off of in case of emergency. This amount can be anywhere between 3-12 months of living expenses depending on the person’s lifestyle. This is an important factor to determine before saving/spending down debt because if you lose your job or a medical emergency arises or your car breaks down, etc. and you don’t have the ability to pay it off; more often than not, you will use your credit card and that is how people will spiral into debt. By setting up an emergency bucket, you are preventing yourself from getting stuck in bad debt.
What type of debt do I have?
Recognizing what type of debt you have will help you decide if it makes sense to pay off and or save. People often think that all debt is bad debt and that’s not the case, so it’s important to recognize the difference. Debts, that give you the opportunity to acquire property with the potential for price appreciation (i.e., Mortgage) or debts that give you the opportunity to learn & grow (i.e., Student loans) are generally considered to be good debt. And depending on the interest rate, do not have to be paid off quickly and can be balanced with saving for retirement. On the other hand, there are certainly bad debts that should be avoided at all costs and if not, should be paid off as soon as possible. These types of debts generally leave you with nothing to show for and often put you in a worse spot than you were previously (i.e., Credit Card & Car Loans). These bad debts should be paid off sooner rather than later and normally should be prioritized over gung-ho savings.
What is the interest on my debt?
Over the last 2-3 years, homeowners have enjoyed the historically low interest rates (2%-4%) offered by lending companies for their mortgages. Debt like this is good and should be paid off by paying the bare minimum. The idea behind that is, by using the dollars that you would have allocated toward paying off your mortgage faster can instead be invested for the long term and hopefully outpace the 2%-4% mortgage interest rates. On the other hand, there are debts, like credit cards, which carry interest rates anywhere north of 20%. Debts, like these need to be wiped out as soon as possible. But that is easier said than done.
Once you’ve established your emergency bucket and have determined what type of debt you have, it would be a good idea to talk to your financial advisor to develop a holistic plan around your goals and how to conquer your debt.
If you have any questions, please call the office at 215-376-5530 or visit our website at www.thrivewealth.com.