Personal finance can be difficult at times, especially when you have to choose between saving money and paying off your outstanding debt. At first thought, you might consider paying off your car, mortgage, credit debt, or home repayment. However, an emergency falls upon your head making you realize the importance of maintaining an emergency fund. So, how do you handle your personal finance?
Problem with the debt-only approach
According to a report released by the AARP Public Policy Institute and Demos Group, nearly 41 percent of the families aged between 55 and 64 have credit card debt. It means that the situation is much worse than what we expected. Some people may find it sensible to clear off their debt without keeping any savings at all. But, how do you plan to manage an emergency with zero savings? You might have to rely on your credit card for any emergencies, which in turn will make the situation even worse.
Further, without proper savings for your retirement, how are you going to survive the elderly years? According to the experts, people who start saving early for their retirement enjoy the benefit of compound interest.
Problem with the savings-only approach
If you have some disposable income at the end of each month and you plan to save it, you end up paying high interest rate for your credit card debt. Most of the credit card debts outmatch the interest earned on investments by a huge margin; you might end up paying higher interest than what you receive from your investments. In addition to it, you may end up retiring with an outstanding debt and might even have to face financial crisis during your retirement.
Solution: Analyze your personal finance/financial position
The only solution to the problem is to analyze your current financial position and prioritize your investments/spending accordingly. Simple mathematics suggests that it is best to pay off our debt before saving money. However, people consider their emotions instead of logic in personal finance. Here are a few tips for analyzing your personal finance.
- What type of loan do you owe? You have to consider the type of debt you own. On an average, a credit card debt would cost you 16% where as a student loan is available against an interest of 6% to 7%. If you own credit card debt, it makes sense to pay off your debt before investing. However, if you have an education loan, it might be helpful to save money providing you earn a higher interest rate.
- Never turn down free money: If you employer offers matching contributions for your 401(k) retirement plan, invest as much as possible. It is tax-free money and can lower your tax burden.
- Set-up an emergency fund: If you are caught between savings and spending without having an emergency fund, choose to save. It is important to have an emergency fund for accidents, car repairs, and sudden illness. An ideal amount is to have the savings of nearly 6 to 8 months; however, you can start with a small savings account with $1000 to $2000. Once you have an emergency fund, it is best to focus on paying off your debt.
If you are not sure about any of these approaches, divide your money into two equal portions and invest in both. You need to consider factors like whether you can rely on someone in case of emergencies or not. It might help to choose a financial planner to do the job for you.