One of the most common questions our clients ask is “What should I do first? Should I pay down debt or save and invest?”
Although this seems like an easy question, at first, the answer can quickly become complicated. Based on your individual situation, paying down debt could be in your best financial interest. However, prioritizing debt over an emergency fund or investing could risk your long-term financial security. So, how can you know what is the best solution for you?
These 4 steps will help you assess your financial situation and get you on your way to financial security.
A key factor in determining your financial priorities is assessing your current and future financial obligations. For example, if you are looking to purchase a home in the next year or two, you may concentrate on saving for a down payment to reduce future debt. If you plan to retire soon, you might want to center your plan around saving for retirement and paying off your mortgage.
Financial plans vary from person to person, so understanding what financial milestones are ahead and factoring them into your overall budget is crucial to finding a solution that fits your needs.
Over 80 percent of Americans have a debt of some sort, but some debt is worse than others. The first step to determining your financial priorities is assessing your current savings, debt, and income. Start by addressing your debts. You should be aware of the amount owed, the interest rate, and the loan term.
Next, look at your savings. Before paying down debts, you should have an emergency fund. Your emergency fund should be a savings account with between 3 to 6 months of expenses, for unexpected events and expenditures. If you have an emergency fund, begin focusing on other necessary savings, such as retirement. Although high-interest debt should be a priority, do not let it distract you from saving for retirement. It is suggested if you have a 401(k) or employer-sponsored retirement plan, save at least to the employer match.
Before you can begin to save, invest, or pay off debt, you need to know how much money you have available, after covering all expenses. Creating a spreadsheet or notebook to track all expenses will not only help determine how much money you can dedicate to debt and savings, but it can also uncover unnecessary expenses, such as frequent meals out or other small, but costly, extras.
Once you have evaluated your income vs. spending, you can begin to generate a budget. This is when you decide your priority: Debt or Savings.
A general rule of thumb: address high-interest loans, especially credit cards, and any debt above 5 percent before tackling any other debts or saving. This will reduce the amount you will pay over time because you will not be losing money to high interest.
After confronting high-interest loans, next, you should start contributing to your retirement fund and any savings goals. During this time, you should also be working to pay off other debts. Even if it is only a few extra dollars a month, contributing over your minimum payment can reduce the amount of interest you will pay over time.
Contact a Duncan Financial Group advisor today, for professional advice or to design a savings and debt management plan that fits your needs.