By Lyle Solomon
No matter how much money you make or where you are in life, you will always have to choose between spending and saving. And when it comes to big financial goals, like paying off debt or saving for retirement, it’s not always clear which one to work on first.
You will have a better financial future if you choose to save or pay down debt instead of spending any extra money you might have. Also, you don’t have to choose between one or the other. Sometimes it makes sense to pay off debt and invest simultaneously, and here’s how to prioritize both goals.
1. Create A Budget
Budgeting is one of the keys to effective financial management. Budgeting is a good process that helps people allocate their money so that their “needs” are met while also making room for their “wants.” By creating and sticking to a monthly budget, you can avoid overspending and drowning further in debt. People who do not adhere to a monthly budget usually spend more than they should, and they’re left wondering where their money has gone or why they don’t have any because they can’t keep track of their spending. Budgeting gives you financial control.
Making a budget makes it simple to increase your savings. Using the budget, you can set aside a specific monthly savings amount. Without a budget, spending extra money without thinking is easy, leaving you with very little at the end of each month.
2. Set Up An Emergency Fund
According to a survey by Bankrate, more than half of Americans have an emergency fund with less than three months’ worth of expenses. An emergency or rainy day fund is money to cover unexpected costs or financial emergencies. Life can be unpredictable, and financial setbacks can occur anytime — a job loss, medical or dental bills, a fender bender, or a significant appliance that stops working unexpectedly.
Yes, there may be other ways to get cash quickly to cover the cost of an emergency, such as credit cards, unsecured loans, home equity lines of credit, or borrowing from other sources, such as retirement funds. However, these options usually come with high-interest rates or penalties. Though there are many reasons to have an emergency fund, one of the most important and appealing is to avoid debt.
Putting money aside in an emergency fund helps to keep it out of sight and out of mind. It makes you less likely to spend money on a whim, no matter how much you want. You’ll also know precisely how much you have and need to save, which is preferable to keeping a cash buffer in your checking account.
3. Focus On High-interest Debts
You can save a lot if you pay off loans with high-interest rates. So, the smart thing is to pay off these debts as soon as possible. Debts with high-interest rates can be burdensome, and credit card consolidation programs are an excellent way to combine multiple credit cards.
After you pay off these debts, you can make regular payments on loans with lower interest rates, like a mortgage, student loan, or car loan. But it is better to pay your secured debt on time, so you don’t risk losing your collateral.
Having a lot of debt can damage your credit score. Savings accounts don’t appear on credit reports because they aren’t linked to borrowing or debt. A savings account on your credit report won’t hurt your credit score. Your credit score will increase if you pay off your debts, and mortgages and loans will cost you less.
4. Automate your savings
Consider automating as much as possible as soon as you decide how to allocate your money. For example, you may be able to set up automatic student loan payments, direct deposits to your savings account, and 401(k) plan contributions.
By automating, you can avoid second-guessing your savings versus debt-paying decisions and the stress that often comes with constantly analyzing your financial situation.
Not only can automating payments save you money on late fees and overdraft fees, but it also facilitates the process of remaining active and accountable on your accounts. It may also help to keep your credit score from being harmed by late payments. Payment history accounts for 35% of your credit score.
You can turn savings deposits into another monthly expense by automating them. It can help you prioritize your savings contributions, reducing the temptation to spend those funds without planning. When you automate your savings, paying yourself first when your paycheck arrives becomes much more manageable.
The Bottom Line
You could save hundreds or thousands of dollars in interest charges over the life of your loans if you focus on debt repayment. You may benefit from saving and paying off debt simultaneously, and you should be able to cover unexpected expenses. Furthermore, you may reduce your income tax liability by contributing to a 401(k and IRA and continue to deduct interest on your mortgage and student loans.
Saving, investing, and debt repayment are not mutually exclusive activities. While you may want to concentrate on one, you can do all three simultaneously. It’s about striking a happy medium that lets you put your best financial foot forward now and in the future.
About The Author: Lyle Solomon has extensive legal experience as well as in-depth knowledge and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998, and currently works for the Oak View Law Group in California as a Principal Attorney.
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