Facing a financial dilemma? We are here to help.
Every month, we’ll answer questions from you, our readers to help you get a better understanding of your finances.
Got a question? Send it to us at hello@clevergirlfinance.com or leave it as a comment below!
Today's question is from "Marcia, age 32" and she asks:
A decision I’ve been struggling with is whether I should focus on building my savings or paying off my debt. I currently have about $98,000 in debt, which includes my student loans, my car loan, and some credit card debt. What would you advise?
Saving money and paying off debt are two important aspects of anyone’s financial journey and Marcia isn’t alone when it comes to making decisions about saving money or paying off debt. So should she save money or pay off debt?
Well, it is possible to do both; save and pay off debt
It’s important to plan for your future self right now even if you are tackling a debt balance. This is because in this day and age, you can't count on social security to support you during retirement. In fact, it may only cover 40% or even less of your income!
Additionally, you want to try to pay off your debt as quickly as you can to avoid the burden of accumulating interest which can significantly increase your debt balance over time. It’s estimated that the average American will pay over $130,461 in interest over a lifetime.
That said, here are 3 key steps to successfully save and pay off debt at the same time:
Create a buffer: If you currently have no savings, it is a good idea to work on saving a $1,000 to $1,500 cash buffer at a minimum. This amount can cover your most basic emergencies. e.g. an unexpected utility bill, an emergency plane ticket, an emergency car repair etc. Once this is in place, you can build savings into your budget to your buffer to 3 to 6 months of your basic expenses e.g. to cover rent/mortgage payments (in the event of a job loss), food, required medicines, transportation and core utilities.
Set up your contribution to your employer's sponsored retirement plan (if one exists): If your employer offers a savings match, then it's worthwhile to get the full match starting now. This 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 to create a nest-egg for your future self. Don’t have an employer retirement account option?Alternatively, you can open an IRA.
Create a budget with a focus on aggressively tackling your debt if you are able to: 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.
A note on why you need a cash buffer in place
If you’ve devised a plan to repay your debts but haven’t established an emergency fund, it’s important to allocate funds for unforeseen circumstances before aggressively tackling debt repayment. This could mean, making minimum payments until you have that initial $1,000 to $1,500 set aside.
Life is unpredictable, and setbacks can occur unexpectedly.
While you may want to put extra money towards debt to pay it off as fast as possible, it is wise to put extra money toward creating a financial cushion. When emergencies happen, we can often accrue debt trying to deal with emergency situations.
Many years ago, I was in a car accident, and fortunately, the other driver and I were unharmed. However, because I didn’t have a savings, I had to rely on a credit card to pay for the costs my insurance didn’t cover. It took me years to pay off that debt. An emergency fund would have saved me a lot of money.
Remember, once you’ve built a solid savings buffer, you can continue paying off your debt.
If you need more financial strategies or guidance with paying down debt, be sure to check out our completely free course, Destroy Your Debt!