In the ever-evolving world of personal finance, the debate between paying off debts and saving money has been as enduring as the chicken-or-egg conundrum. It is a question that can keep you up at night: Should you channel your hard-earned cash into wiping out debts? Or, is it wiser to stack it up in your savings account?
Understanding the Basics: Debt vs. Savings
Kampus / Pexels / Figuring out whether paying off debts is a sane financial decision is a difficult process.
The answer, as frustrating as it may sound, is not a straightforward one. It is more about finding a balance and strategy that aligns with your financial goals and current situation.
The High-Interest Debt Dilemma
First, let's lay the groundwork. Debts, especially high-interest ones like credit card debts, can be like quicksand for your finances. The longer you stay in, the deeper you sink. On the other hand, savings act as a safety net, ensuring you are not caught off-guard by life's unpredictable expenses. Think emergency car repairs or unexpected medical bills.
Andrea / Pexels / There is one thing that impacts both (debt and savings:) Tax for savings and interest for loans.
A key player in this decision-making game is the interest rate. Compare the interest rate on your debts with the return on your savings. If the interest on your debt is higher than what you earn from your savings, it usually makes sense to pay off that debt.
Why? Simply because the money you are losing through debt interest is more than what you are gaining in savings interest.
Credit card debts are notorious for their high-interest rates. Paying these off should be your top priority. Let’s say you are paying 20% interest on your credit card balance. By clearing this debt, you are essentially getting a 20% return on your money. This is something even the best investment plans might not guarantee.
Before you throw all your funds at your debt, it is crucial to have some emergency savings. Experts often recommend having enough to cover at least three to six months' worth of living expenses. This fund acts as your financial shock absorber, cushioning you from unforeseen expenses without needing to dive back into the debt pool.
The Snowball and Avalanche Methods
When tackling multiple debts, you have two popular strategies: The snowball and avalanche methods. The snowball method involves paying off the smallest debts first, gradually working your way up to the larger ones. It is a morale booster, giving you the psychological win of clearing debts quickly.
Antoni / Pexels / With the Snowball Method, you can pay off smaller debts first and save as much as you can in the meantime.
On the other hand, the avalanche method focuses on paying off debts with the highest interest rates first, which makes more sense mathematically.
While focusing on debts, do not neglect your retirement savings. If your employer offers a retirement plan with a match, try to contribute at least enough to get the full match.
Small Changes, Big Impact With Lifestyle Adjustments
Look for ways to cut back on your expenses. Maybe brew your coffee at home, cycle to work, or cook more meals. These small savings can be funneled into your debt repayment or savings plan.
Likewise, use financial apps to track your spending, create a budget, and monitor your debt repayment and savings progress. Seeing your debts shrink and your savings grow can be incredibly motivating. If you are feeling overwhelmed, consider speaking to a financial advisor. They can provide personalized advice tailored to your specific situation.