The next time you plan for a trip, be sure to take these expenses into account.
The last two posts in this series have been primarily about saving early and wisely. But what if you didn’t do that in your past and now have a lot of debt? What should I do first, save or pay off debt?
It’s a question commonly asked by clients and friends facing this dilemma. If you have enough income our first suggestion is to do both. Develop a plan of systematic debt payments and saving contributions that you can manage within your budget. But many people who pose this question feel that they are not in a position to do both simultaneously. In this case, saving money instead of paying off high-interest debt would be a huge mistake.
True if your only savings is your emergency reserve, paying off your debt first can be risky. But it’s a risk you have to take if you ever want to be debt-free. Here’s why. Once again it comes down to the math.
Notice we referenced HIGH-INTEREST debt. If you put money into a typical savings account (with the “high yield” ones currently offering about 1%) instead of making larger payments on a debt that has an interest rate of 30%, you’re still paying 29% and not doing anything to shorten the length of time you’re paying that debt off. Unless you pay the debt off quickly it doubles in about 2 and 1/2 years according to the Rule of 72. By saving instead of paying off the debt quickly you would be trading freedom from debt for a sense of security that depending on other financial circumstances may not be genuine.
So how do you take this risk of paying debt off first responsibly?
One option is begin by focusing on paying off the smallest debt first. Pay more than the minimum on that debt while maintaining minimum payments on the others. Once the first debt is eliminated, you can either roll that payment amount on to the next smallest debt or split the payment amount between your savings and the next lowest balance. Repeat this process until all your debts are gone. An alternative strategy is paying off the debt with the highest interest rate first thus saving yourself added interest payments.
Other options to consider when eliminating debt is consolidation to zero or low-interest rate credit lines or debt relief programs. At the end of it all there is no one size fits all approach to the question of whether to save or pay off debt first. If you are unable to decide which method would work best in your situation, consult with your banker or other financial professional for a personalized plan.
If you’re over the age of 18 it’s likely you’ve made some mistakes with your money. Even I have made some because let’s face it no one is perfect. So we’re starting a new series on the money mistakes you want to avoid if you haven’t made them yet.
Mistake #1: Not saving from an early age.
First let me state this mistake is not always our own to claim. I strongly believe that anyone who has a baby should make their first outing into the general public include a trip to your local bank or credit union to open at least a savings account for the child. So if you didn’t have one as a child, this is one time you can rightfully say it is your parents’ fault.
Now I understand some parents become parents unexpectedly and that $25 you need to open an account needs to spent on diapers, formula and all the other necessary baby paraphernalia. That’s when taking it old school and getting a piggy bank to save that spare change will help get you there.
Once you have the account opened for your child, create a regular savings plan. Determine what amount you can reasonably deposit into the account on a regular basis. Then stick to it! The great part about starting this savings plan for your child is that they have a longer amount of time for the money you deposit to grow, no matter how small the amount. I recently had the opportunity to help a business partner grasp compound interest by stating, ‘You’re earning money (interest) on free money (interest)’.
Once you’ve started your child off saving early, it’s important that you include them in the process when they are ready. There’s no set age for this as children all mature differently, but it can be as simple as teaching them what change in your local currency looks like so that when they spot some carelessly discarded on the ground they know to pick it up and put it in that piggy bank you got them earlier. From there you can teach them how to count it, show them how to deposit it in their account, and start helping them to understand how to read their bank statements. So far no complicated math involved.
But it’s simple Math, something you can use for your own savings no matter when you started and that you can teach your children once they learn how to divide. To get a general idea of how long it would take to double your money simply from interest alone, divide 72 but whatever interest rate their account earns. For example, a savings account earning 1% (one of the highest rates we could find for a savings account btw) would double in 72 years [72/1=72]. Just one more reason it’s important to start saving early.
Of course since you’re adding money to the account it won’t take quite as long to see your money double. But let’s say you want to earn more than 1%. Up until this point we’ve only been looking at regular savings accounts and we haven’t mentioned a specific savings goal. Let’s talk saving for retirement now. Once you have a couple of hundred dollars in that savings account it’s a great idea to go ahead and open a Roth IRA at an early age. That concept of compound interest applies to those accounts also, they can be opened for children, and require relatively low initial deposits, some as low as $100. There are other benefits as listed in this Investopedia article. Talk to your financial professional for more details.
Check back in 2 weeks for another money mistake.
This will be a recurring series of posts regarding everything I was told or wish someone had told me when I was a teen about money. Of course, teens don’t read unless it’s about vampires, werewolves, alien love affairs or some other fantasy nowadays so eventually these will have to morph into videos.
Save more than 10%
When I was young I heard the whole save ten percent thing. Something about being in the Bible belt; give 10% to God put 10% in your savings account. But if you’re a teen who actually has a job in this still slow economy (ignore the hype about being in a recovery), I advise if you don’t have to take care of yourself with that money because of parents that can’t cover all of your ESSENTIALS due to the current job market, put more than 10% in your savings account. That way by the time you’re legal you’ll already have that rainy day account a lot of Gen Y and some of you Millenials won’t have but will desperately need. Don’t believe me – look at the poverty rates from the Pew Research Center for teens and younger. Thanks @robferdman for posting!