Should you save for the future or throw every extra cent at your debts to pay them off quicker? This debate is one that pops up all the time and causes a lot of confusion. Some personal finance experts advocate combining debt reduction and saving for retirement, but what if your money doesn’t stretch that far? Here at Money Crashers, we sway towards paying down debt first, and then use that extra money towards funding your retirement accounts.
The reasoning behind this approach is pretty simple: when you no longer have to allocate a set amount of money for debt repayments each month, you’ll have more money to use for funding your retirement, and you don’t have split priorities to carefully juggle. If you’ve only got so much money to spare once you’ve met your essential monthly bills and budgeted for semi-regular and occasional expenses, dividing what’s left between retirement funds and paying off debts can mean that there’s not much going in either fund. As far as your debts go, you’re extending the time that it’ll take to fully pay them off and as a result, you’ll be paying more interest. It’s not uncommon for credit cards to have interest rates of 18% or higher, which is obviously a big expense on top of the actual debt that you’ve racked up.
Even if you don’t have credit card debts, you may have student loans, car loans, or home equity loans. The interest rates on these may not be as high as on credit cards, but it still makes sense to get them paid off as soon as you can and free up your monthly income. Your monthly income is your most important weapon to help you build wealth, and you can’t save aggressively for retirement if you’ve got thousands of dollars going out the door every month to a bunch of banks.
How about once your debt is payed off? Well, if a good portion of your income has been used to fund your debt repayments each month, then you’re used to this and won’t miss the money if it’s then used to fund your retirement savings instead. After all, that money hasn’t really been “your’s” for a while, because it’s been going straight to creditors, so adopting the mindset that it’s still not “your’s” now that you’re debt-free makes it easier to start building retirement savings as soon as possible.
Do you disagree? Do you have an argument for saving for retirement right away? We want to hear it.