If you have student loan debt, credit card debt, or a balance on a personal loan, the smart thing to do is pay those debts off as quickly as possible. But as anyone who is currently dealing with debt knows, just because you that obligation to repay doesn’t mean you don’t have other financial priorities. You’ll likely want to reach other goals, too, like establishing an emergency fund or maxing out your IRA.
E.M. over at Journey to Saving recently discussed this financial conundrum, which got me thinking: what should you prioritize when you’re trying to allocate your cash to different goals and working at paying off debt? As with most things in personal finance, there is no one answer that will suit everyone’s unique situation – but we can come up with two main solutions that you can analyze to determine which one makes the most sense for you.
Paying Off Debt with the Debt Emergency Philosophy
Some people believe that having debt is an emergency in its own right, and there’s nothing wrong with letting debt repayment be your sole financial focus until all your debts are repaid. This makes a lot of sense, especially if you have a relatively manageable amount of debt – something under $10,000, for example. You could get onto a bare bones budget, limit your expenses to cover only what you truly need, and then tackle this amount of debt in 12 months or less by throwing every cent that you earn in a month at your loan or credit card balances.
I believe this is a good approach for smaller amounts of debt because it is exhausting. Having a single-minded purpose and devoting every last penny you can spare to your debt repayment is going to eat away at what you owe relatively quickly – but it’s hard to do this month after month after month with no concern for other financial goals or even a bit of “fun” spending.
This is also a good approach if the interest rate on your debt is high. The longer you hang on to your debt, the more you’ll end up owing in the long run thanks to interest. So if it’s a high rate, your emergency is to get rid of it as fast as you possibly can. It truly is your emergency.
Paying Off Debt with the Balanced Approach
If you have larger sums of debt, ignoring every other financial goal you have might not be the best strategy. You’ll be paying off that debt for a long time, even if you’re exclusively focused on repayment. You may want to devote the largest percentage of available cash to paying off debt, but you might also want to hold back a little bit to put toward something like retirement.
Your debt should still be your biggest priority, because even with a low interest rate it’s costing you money every month that you continue to carry a balance. But if you’re young, you cannot afford to not invest anything at all. Regardless of whether or not you have debt, if you have access to an employer-sponsored retirement plan you should be contributing enough to get the match. Don’t worry about adding in more while you’re working on repaying your debt – but at least grab that free money that’s being offered to you.
You might also want to consider opening a traditional IRA to take advantage of the tax benefits. What you contribute to an IRA is tax-deferred, meaning you’re taxed on the money when you withdraw it instead of being taxed in the year you put money in. This can amount to some serious savings on your tax bill in April, and that could free up funds to continue putting toward your debt.
You can also be saving for something like an emergency fund. Even if debt is your most pressing financial issue right now, there’s no telling when an unexpected expense will pop up and blow a hole through your budget – and you do not want to resort to adding to your debt in order to take care of it. You can have a set amount of money you devote to paying off debt every month, and if you have some extra money left over, don’t spend it! Add that surplus to your savings.
Or make extra savings into a game. Find easy ways to save a few bucks here and there. Maybe you can pay yourself $5 every time you do a workout (instead of buying a post-gym smoothie every time – make your own at home), and at the end of the month you transfer your “gym earnings” to a savings account you established to hold your emergency fund. Or challenge yourself to see how much you can ride your bike or take public transportation rather than using your car. Move what you didn’t spend on gas to your emergency fund.
Pick a Method that Makes Sense for You – and Stick to It
Taking a measured, balanced approach or working full-out to get rid of your debt once and for all – either way, you’re doing awesome by repaying your debt and moving toward more financial security. What’s important is that you choose an method for paying off debt that works well with your unique situation, and is something you can stick with over time until you’ve met your goals.
Track All Your Accounts With Personal CapitalPersonal Capital lets you see all of your accounts in one convenient place. Sign up now for free.
I’m paying off my debt with a more balanced approach but may start to lean closer to going at my debt full force. Part of me wants to go all out to pay off my student loans but another part of me knows that time is on my side and wants to take advantage of the compounding effect of investing today.
It’s difficult to stick to one plan but as long as you are lower your debt you are heading in the right direction.
Kali Hawlk says
Sounds like you have a great plan in place, Cedric. I would feel the same – super tempted to go into super-debt-repayment mode, but knowing that it’s also smart not to get so caught up in it that you have to then deal with missed opportunity costs.
Thanks for the mention, Kali! There are a lot of paths you can take in the journey to pay off debt, and as you said, everyone is in a different situation. If I were planning to stay settled instead of moving I wouldn’t have prioritized an emergency fund; debt would have been my sole focus. I’m just glad I started investing, and can’t wait to feel a little more secure with our living situation so I can focus on debt.
Kali Hawlk says
I like the balanced approach you’re taking. I think that’s smart, especially if you’re at a point with your debt that it is fairly manageable.
Just pay those loans off. Screw the market. We’ve gained and lost in the market. One thing that was a guaranteed win was paying those frickin loans off. PLEASE do that – please do, for your sake and the sakes of your loved ones. Old guy here who’s been there, done that. Best advice I can give you is LOSE the LOANS ASAP!!!!! Those market gains you’re afraid you may miss out on come and go. Paid off loans just GO – far, far away.
Kali Hawlk says
Paying off your loans should always be a top priority, for sure. But I do think there are some situations where allocating some money to investments is a smart decision so long as you’re investing with a long-term goal in mind (rather than a short-term gain).
I’m of the camp that thinks that it’s best to kick the debt to the curb first, then focus on rebuilding savings and working on investing. But that’s just me and different things work for different people. Debt is mentally and emotionally exhausting at the best of times, so any way that can ease that burden is the best way!
Kali Hawlk says
I think I relate more to that way of thinking, too, Daisy. When something bugs me, it REALLY bugs me, so I’d want to work overtime to get it taken care of as fast as possible!
Jeff @Project Ikonz says
Well there is one solution that i think everyone will agree and that is receiving more money. Write a million dollar blog, easier said than done. Get a side hustle on top of your day job. Work hard and work smart. Also a change of mindset, instead on getting rid of debt focus on how to retire a millionaire. Even if you fail with a goal like that then at least you got rid of your debts. Did that make sense?
Kali Hawlk says
I think it did make sense, Jeff 🙂 I agree that earning more money is certainly a good move to make if you can. Like you said, work hard AND work smart, and set goals that are more about gaining wealth than solving wealth problems. But, that does leave out those who are currently in debt and are still working to get out. I think this advice is excellent for people once they get out of debt and understand that they NEVER want to be there again. For those that are still working toward being debt free, it may be hard to focus solely on gaining wealth rather than eliminating debt – but again, your logic does make sense as people can get so caught up in “racing to zero,” in terms of not having a negative net worth, that they miss opportunities to actually grow and gain wealth.