It’s a common concern: Should you focus on saving more money, or prioritize paying down debt? The answer: Yes.
There is no precise formula, but you shouldn’t sacrifice one goal for the other. Rather they should be done in tandem, using practical strategies that make sense given your financial reality.
Should you save your money or pay down your debt?
While you can allocate more money to one goal or another, you should save at least a little money each month and work towards paying off debt.
“Focusing only on one approach at a time could have negative effects on your long-term financial health,” said Suzanne Schmitt, head of financial wellness at New York Life.
For instance, contributing to your savings, but not paying at least the minimum amounts due on your credit cards can lead to late fees on top of hefty interest, “which could dig you into a deeper credit card debt hole that is harder to get out of,” Schmitt said.
On the other hand, if you concentrate on paying down debt, but don’t contribute to emergency savings, you might be unprepared when expenses pop up, like a health emergency or an unexpected income loss. Without a rainy-day fund, you may have to take out a loan and go into debt, anyway.
When saving should be the priority
Saving should always be part of your financial plan. But it should be the priority when you don’t have at least one month’s worth of expenses saved up.
If your savings are shallow, you’re not alone. Nearly a third of Americans have less than $500 set aside in emergency savings according to a recent survey by Edward Jones.
Ideally, your emergency fund should contain enough cash to pay three-to-six months’ worth of basic living expenses, including rent, food and debt payments. This way, if you are laid off or have other financial trouble, you have some time to find another job and juggle responsibilities.
A robust emergency fund also gives you peace of mind in what is otherwise a stressful time. While you may not know where your next paycheck will come from, you can count on the money you’ve saved in the bank.
The importance of an emergency fund
An emergency fund is a safety cushion. It exists so you don’t have to lean on high-interest credit cards or loans when money troubles mount, such as a lost job, big medical bill or a car in need of repair.
Once you have a healthy emergency fund, you can branch out and save for other things, like a vacation or holiday gifts. You shouldn’t make withdrawals from your emergency savings for non-essential expenses.
If your savings “tank” is empty but your debt is manageable, you may be in a good position to tweak your budget so you can save money while still keeping up with your debt payments, said Bruce McClary, senior vice president at the National Foundation for Credit Counseling.
Tips to help you save money
A way to start saving is to stash at least 10% of your net income (your after-tax, take-home pay) in an emergency fund as soon as you get your paycheck. If that’s too much, aim for 5%. And, if you’re living paycheck-to-paycheck, putting small amounts ($5 here, $10 there) in an emergency fund is a good start.
Among the tips for saving money are:
- Develop a budget. This will give you a clear idea of how much money you’re making and spending. You can use methods like the 50/30/20 budget rule and create (and track) your budget with a spreadsheet or a budgeting app.
- Look for ways to cut costs. Get rid of unused subscriptions, eat at home more often or look for a roommate or cheaper lodging.
- Set financial goals. Saving money for a specific purpose can motivate you. You can establish both short-term financial goals, such as setting up an emergency fund or setting aside a down payment on a new car, and long-term financial goals, such as planning for retirement or covering your child’s college education.
- Automate your savings. Scheduling automatic transfers from your checking to your savings account can simplify the process, and you won’t even miss the money since you never felt it in your account in the first place.
When debt repayment should be the priority
You should prioritize debt repayment over savings whenever, well, you have high-interest debt that inhibits your ability to meet your other financial obligations.
It is a real-and-present danger when your debt is well past due and you’re being hounded to make good.
“Any account in jeopardy of being sent to a debt collector should be your financial focus,” said McClary.
The National Consumer Law Center recommends that you prioritize any debt that would hurt your family if it goes unpaid.
These debts may include auto loans, mortgage payments, apartment rent and utility bills. Once those are taken care of, then shift your focus to debts like credit card bills, medical bills and friends-and-family loans, the center says.
Tips to help you pay down debt
You can take a number of steps to pay down your debt, such as:
- Don’t add on more. This may seem like a no-brainer, but it can be difficult to do. Resist the urge to rack up even more debt: Don’t buy things on credit; don’t get a new car, boat or jetski; don’t borrow cash from family and friends.
- Pay more than the minimum. Paying more than the minimum amount due each month on your credit card accounts (or any other loan) will help you pay it off faster and reduce interest charges.
- Consider debt consolidation. Consolidating higher-interest debts into a lower-interest loan or 0% balance transfer credit card could simplify your finances and allow more of your payment to go towards your debts rather than loan interest.
- Stick to a debt payoff strategy. For instance, you might adopt the “debt snowball” method. This method wipes out your smallest balances first to score quick victories and then moves on to debts with increasingly larger balances. Or you might try the “debt avalanche” method, which focuses on the highest-interest debt first.
- Seek help. If you’re feeling overwhelmed, ask your creditors about setting up a repayment plan with lower monthly payments or speak with a counselor at a nonprofit credit counseling agency.
How to balance your savings and debt
Juggling the need to save money and reduce debt can be tricky. But it can be done. Keys to accomplishing this include developing a budget and coming up with savings and debt payoff strategies.
The key is to have a goal and track your progress. For instance, if your savings account is empty, try to get to $100 by the end of the month. From there build up until you have a few days’ worth of expenses, then a few weeks and then a few months.
By tracking this progress, you’ll develop good habits and the confidence that you have the power to positively change your fortunes.
“Financial discipline is not a thing but, rather, a series of behaviors,” said Jeff Roberts, a private wealth advisor at Ameriprise Financial.
Frequently asked questions (FAQs)
You should aim to build an emergency fund with enough money to cover three-to-six months’ worth of basic household expenses.
To determine whether you’re carrying too much debt, some of the obvious signs include being unable to make minimum debt payments, constantly making late debt payments, being rejected for new credit and being incapable of setting aside money for emergency savings.
Another way to look at your debt burden is to calculate your debt-to-income ratio. This ratio represents your monthly debt payments divided by your gross monthly income. Generally, the ratio should be no higher than 43%.
You should not use your savings to pay off debt unless absolutely necessary. Why? Because if you drain your savings, it could force you to accumulate more debt when an emergency arises. It is better to cut your ongoing spending.
