Saving or Paying Down Debt: Why 50/50 Works
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Even with the best intentions, there always seems to be a bump on the road towards financial freedom. You want to save up for this but you also have to pay for that.
Can’t really catch a break can you?
So you and I both have financial goals that we want to accomplish. For me, I’ve been saving up to make Roth IRA contributions. But, I also have to pay off my student loan debt along with some credit card debt. My mind says that focusing on one goal at a time would be easier to stay motivated – since it would serve as a quick psychological win as well.
It turns out that giving my all towards a single goal just won’t work. That’s why so many personal finance experts advise on splitting discretionary income between savings and paying down debt. We must seek to balance the need for a fallback and the need to pay our dues.
Why Not Save, Exclusively
Putting 100% of your spendable income into a savings account will mean that you are paying the minimum towards your debt while the interest rate in your savings account won’t be able to match the interest on your debt. So, it is actually taking a step backwards because you’d be watching that scary interest start to rack up.
- Debt is will literally cause nightmares. It is the intangible “thing” breathing down your neck. It is the reason for worry, anxiety, and the feeling of never being able to get ahead.
- The detrimental mathematical fact is that debt grows bigger with time, which results in a hopelessly downward spiral. You are handing over money (minimum payment) but somehow, the balance continues to grow.
Why Not Reduce Debt, Wholeheartedly
Holding the status of debt-free puts you at the apex among personal finance aficionados. No wonder everyone strives to release themselves of the strangleholds of debt. Once it is achieved, the road to riches is much less bumpy. Obsession with debt repayment is a good thing but don’t dismiss the possibility of putting oneself into even more debt.
- The lack of an emergency fund or some sort or cash safety net is very much like going skydiving over mountains with no backup parachute – there is no room for error. But sadly, we are human and stuff happens (c’est la vie). An emergency fund of cash is easily accessible when spontaneous events occur without having to put yourself into more debt.
Split Between Savings and Debt
Sure, you may reach your financial goals later than you expected but going 50/50 will be a safe, yet productive, approach.
Once a substantial emergency fund of cash is built, it is time to let that debt-free obsession go into overdrive. Chase the psychological wins with your preferred method of debt reduction. Keep in mind to invest in a retirement plan such as a 401k and/or a Roth IRA.
So, the outline would look something like this:
- 50% towards savings and 50% towards debt
- Emergency fund established
- 10% towards retirement and 90% towards debt
- Debt-free status achieved
- 20% towards retirement and 80% whatever the hell you want
- Stay away from credit card debt
There is no perfect ratio. Shift a little extra towards saving or debt as you please but you must tackle both with reasonable force. Fifty-fifty is just a good place to start.
(Photo credit: nerovivo)
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JoeTaxpayer said:
As with any financial decision, the best advice will be specific to the particular person’s situation.
I’d suggest that one grab a 401(k) company match, if any. This is usually limited to the first 5-10% of one’s gross, but it’s better to get this match even if you owe 18% on credit cards.
Next, I’d say to pay those cards, even before the emergency fund. An emergency is just that, an unusual situation, not daily event. If you owe money at a 9% or higher rate, it should be attacked with a vengeance. A true emergency can always be charged.
Once you’re debt free, I’m back with you, 20% savings.May 15th, 2010 at 1:38 pm
