Should You Save Money or Pay Off Debt?

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Paying debt and saving money are both very important financial goals. They’re also steps you have to take to reach a bigger life goal — living well during retirement. You want to go into retirement debt-free, but focusing on debt repayment now could mean you have to sacrifice your retirement savings. But how do you choose the best place to spend your money?

The Problem Paying Debt Only

If you pay your debt first and put no money in savings, then you have nothing but your credit cards to fall back on if there’s a financial emergency. Unfortunately, you can count on some type of expense coming, and it's usually when you least expect it. Using your credit cards to fund an emergency only makes it harder to pay off debt.

Delaying your retirement savings will have negative consequences. The longer you wait to start saving, the more you have to put aside each month to meet your retirement goal. If you start saving earlier, you get the benefit of years and years of compound interest on your investment.

And the Problem With Saving Only

On the other hand, if you save first and don’t focus on paying down your debt, you end up wasting money on credit card interest. Since credit card interest rates are often higher than savings interest rates, you end up spending more money on debt interest than you earn on your investment.

The other problem with saving first is that you risk entering retirement with debt. You may find that you can’t live comfortably on your retirement savings and keep paying your debt. So you’d have to either live uncomfortably and pay your debt or go back to work until you can pay off your credit cards.

When Saving Can Be More Important

If you don’t have an emergency fund or any liquid savings you can quickly access in an emergency, then take a few months to build one. The ideal emergency fund is six to twelve months of living expenses, but it can take several years to build that type of savings. In the short-term, focus on building a small $1,000 emergency fund. That money will cover many small emergencies like car repairs that would otherwise be charged to your credit card. Once you jumpstart your emergency fund, then you can focus on paying off your debt.

Take advantage of your employer’s offer to match contributions to your 401(k) plan. Don’t turn down free money. There are also tax benefits to retirement savings. The money you contribute to a 401(k) can often excluded from your taxable income, resulting in a lighter tax burden. Even if you take advantage of employer 401k match, you may be able to reduce your spending and still spend a sizable amount of money paying off your debt.

From a financial standpoint, if the interest rate on your debt is lower than the interest rate on your savings or investment, then you’d get a higher return by saving versus paying off debt. This is often the case with low-interest rate student loans. Even so, debt is debt and even low-interest rate debt lowers your net worth and makes you feel burdened.

The Answer Is Both

Ultimately, you should find a balance between the amount you spend on debt and savings each month. It isn’t wise to put off either of these in lieu of the other so come up with a way to split your money between the two. For example, if you have an extra $1,000 each month, you can put $500 toward your debt and $500 toward saving.