When it comes to paying off debt or saving, the question of whether it's possible or makes sense is one that gets asked pretty often. So are you wondering, "Should I save or pay off debt?" "Should I do both?" Well, the answer is - it depends on your current financial situation. However, deciding whether to pay off debt or save can feel overwhelming.
But you don't have to be overwhelmed trying to decide if you should pay off debt or save. By creating a plan you can decide which is best or possibly even do both! So, let's get into the burning question, "Is it better to pay off debt or save?"
Is it better to pay off debt or save: How to decide
There are all kinds of debt people deal with—student loans, credit cards, car loans, medical debt, mortgages, and more. Depending on your financial situation, it may make sense to pay off debt first before saving.
It might also make sense for you to save a little first before aggressively attacking your debt. It's also very possible to save and pay off debt at the same time.
However, for any of these scenarios to be successful, you are going to need a smart strategy.
When does it make sense to pay off debt before saving?
Whether or not you have an emergency fund will help you determine if you should save or pay off debt first. An emergency fund is one of the most important things to have to prevent financial hardship.
This should contain 3 to 6 months or more of basic expenses. You should at the very least have a small rainy day fund of $500 to $1,000 to start.
If you are just getting started with your debt pay-off journey and you already have some savings in place, that's great! In this scenario, it may make sense for you to pause saving more and instead focus on aggressively paying down your high-interest debt.
Already having savings put aside means you already have a buffer in the event an emergency or an unplanned circumstance occurs. If your savings adequately covers what you need for your emergency fund needs and short-term goals, you may decide to use some of it to pay down your debt. Especially if the interest on your debt far exceeds the interest on your savings.
Once your high-interest debt is paid, you can shift your focus back to ramping up your savings. If you fit into this scenario, then paying off debt before you continue saving makes sense.
When does it make sense to save before paying off debt?
If you have a debt repayment plan in place, but you don't already have a rainy fund, then you want to first put aside a small amount of money before focusing on your debt. Life happens, and there's no way to predict when and how something will not go according to plan.
Having a small amount of money in place will help you avoid taking on more debt to get yourself out of an unplanned situation.
So is it better to pay off debt or save in this scenario? If you are in this situation, then saving some money before you focus on debt repayment makes sense. Once you have money set aside, you can focus on your debt and then come back to saving money more aggressively.
What about investing?
So, now you know how to determine whether to pay off debt or save, but what about investing? In my opinion, it makes sense for you to invest while you are paying off debt. There are a couple of easy ways you can do this:
Contribute to your employer's sponsored retirement plan
The first way to invest while paying off debt is to contribute to your employer's retirement plan. If your employer offers a 401 match retirement plan, then it's worthwhile to get the full match starting now.
This is because an employer retirement plan contribution match is essentially free money! If your employer doesn't offer a match, it's still a good idea to contribute 5% to 10% to your retirement savings anyway.
Open an IRA
Self-employed? You can still save for retirement. You can open up an IRA and contribute a small amount to it, for instance, 5% of your earnings. An IRA is an individual retirement account that anyone can open to save for retirement.
The rules and tax advantages vary depending on whether you choose a traditional IRA or Roth IRA. However, an IRA is an excellent way to invest while you pay down debt.
Why you should invest while paying off debt
Of course, you want to pay off debt quickly, but you still need to put something aside for retirement.
By making these small contributions to your retirement accounts, you are ensuring that you are putting something towards your future. You'll also be able to take advantage of the power of compounding and the long-term opportunity of time to invest.
Accumulating the amount of money you'll need in your retirement takes time. The more time you have, the more you'll be able to put away, and the more time your money will have to grow.
Given the day and age that we live in, you cannot rely on social security to take care of yourself in retirement. As a matter of fact, social security will only cover 40% of your income (or less)! This is why it's important to plan for your future now.
Create a budget to help tackle your debt
Do you have some savings in place, a plan to contribute towards your retirement savings, and a debt repayment plan already? Then you are essentially saving money and paying off debt at the same time and this is a great approach.
However, to make sure you are successful with this approach, create a budget and become best friends with it.
Your budget will help you track your income and expenses. Your goal should be to keep your expenses as low as possible so you can get aggressive with your debt.
Why the aggressive focus on your debt? This is because the cost of debt in terms of the interest you have to pay is not worth it at all, especially on high-interest debt.
It makes more sense to pay off your high-interest credit card first before saving in a "high interest" bank account. For example, suppose you are only earning 1% in your savings account but are paying 15% in interest on your debt.
Make sure you are aware of the different types of debt you have so you can prioritize them accordingly.
In that case, you are actually indirectly losing money by keeping your money in your savings account. It's better to pay it off asap, and then once that debt is gone, ramp up on your savings and investment goals.
Leverage a debt pay off calculator
Need a little more help on deciding if you should save or pay off debt? Here are some of our favorite calculators to help you compare paying off debt vs. saving or investing, so you understand the actual cost or benefit of what you decide:
Become debt free and save money!
So, keep all these things in mind when asking yourself, "Should I save or pay off debt?" Also, be sure to leverage a debt pay-off calculator to help!
Whatever approach you take to paying off your debt and saving money, make sure you have a strategic plan in place, so it makes sense.
It's also essential to adjust your mindset, remind yourself of your why, and surround yourself with the right influences. This will keep you motivated to accomplish your debt repayment goals.
Learn how to create a debt repayment strategy and destroy your debt with our completely free course! Also, tune in to the Clever Girls Know podcast and YouTube channel for more tips on saving money and slashing debt!