Thank you for all your messages. I’m doing fine after taking some time off. Following on from my previous post, I have received many emails inquiring about how to deal with debt, specifically whether to pay off our debts first or to save some money for emergencies.
This decision can have a profound effect on your finances, so it’s important you make the right one. I’ve compiled a list of important factors to make it a little easier for you. You’re welcome!
So, you’ve finally found yourself earning more than you spend (and there are a great many who don’t). Congratulations! But that’s not the only tricky part. Now you have to figure out how to put that positive cash flow to proper use. Do you pay off those looming debts or do you put it into savings?
You may want to ask yourself these questions:
1) Have I got an emergency fund?
Stashing away some highly available emergency money is a good first step if you do not yet have any savings. You know, in case the boiler breaks or your teenager simply has to go on that school trip to Europe. Even if your debt is accumulating a lot of interest, creating an emergency fund is key to gaining greater financial stability. You’ll sleep better at night knowing it’s there.
My tip: Saving a 6 months’ worth of expenses is quite enough for most families. This varies, of course, with the stability of their income.
2) How stable is my source of revenue?
Do you expect to be in work for the foreseeable future? Or perhaps the company, you work for, is struggling? Maybe your new boss just doesn’t understand that your alarm clock has always been a bit temperamental.
My tip: More often than not, you should tackle your debt first if you have a stable income. Not so sure about your future? Save some money so it’s there for when you need it.
3) What is the interest rate on my debt?
Your credit card interest rate could be 18% or more. If your emergency fund is in place, then paying off a high-interest debt is the wisest investment you can make. Paying down an 18% debt is akin to earning an 18% return. Slay the largest debt monster and then move on to the next larger one.
My tip: If you’re always making 8% on investments, then it doesn’t make a lot of financial sense to pay extra toward any debt with an interest rate below 8%. Pay the minimum on your debt, invest the rest.
4) What interest rate are you receiving from your savings account?
If you haven’t dipped your toe into the unpredictable pool of investment yet, look at the returns you’ll get from a savings account. The interest is almost certainly going to be lower than the interest you’re paying on your debt.
5) What are my financial goals?
Has your teenager come back from that trip to Europe and now wants to study at Cambridge? Perhaps you need to start a savings fund because of specific goals. But if you already have money set aside, then get busy eliminating your debt!
6) What’s important to me?
Which option puts your mind at ease? What are your values? Money in the bank is soothing for some, but others sleep better knowing they’re debt-free. Listen to the emotions surrounding your financial decisions.
My tip: If the difference between your return from investments and the interest on your debt is minimal, then the impact of your financial decision will be minimal too. It’s important to be comfortable and relaxed with your finances.
Let’s be clear. Whether you choose to save money or pay off your debt first, you’ve already made a wise decision. The option, that’s best for you, is entirely dependent on your individual circumstances. If you’re still having trouble, then consider saving a little and paying off a little at the same time. For many, this can be the best of both worlds.
All this ultimately boils down to determining your values, then your goals, and finally the techniques you employ. Be careful not to do it the other way around.
Thank you for reading. I’ll be sharing more techniques and how-to videos soon. Watch this space for updates.
Please feel free to download (click to download) my free resources to help you manage your finances. Leave me a comment if you have any questions or better yet, share this article and benefit someone else.