We welcome guest blogger Miles Victor of Fidelity Homestead with his take on saving vs paying off debt.
Usually, my time is spent fielding questions from people about how they can better their current financial situation. I’m frequently asked about our banks products and how they can help individuals “weather the storms” of life. The truth is that neither the financial institution I represent nor any other possess a product that will help anyone do that. The reality is that our own habits have caused most of the issues facing our country today. We are in a debt crisis, from the top of government to the neighbor next door. Forget the political rhetoric; what can we do about it? This issue has offered an interesting debate of late that I would like to weigh in on. In the survival of the financially fittest, which is better: Saving money or paying off debt? The focus today is to give food for thought and maybe a little conviction of our behavior if necessary.
What’s our problem?
The problem is that we continue to compound problems. Statistically, every family goes through what would be considered a “change in circumstances” or “crisis” every 6 months. These can include life events such as marriage or divorce, change in income, graduation, some kind of accident, or death. These changes, whether negative or positive all impact our finances. Because most American families live unprepared, meaning on average over 70% of families do not have 3 to 6 months worth of expenses saved, we continually finance our problems. Car repair, broken air conditioning and untimely illness could send any number of us hurdling towards desperation.
What’s the solution?
The first thing that should be noted is that both saving money and paying off debt are necessary to have a healthy financial future. In today’s economy, there are no current financial instruments that have an ability to offset the interest most consumers pay creditors on a monthly basis. Credit card interest rates on average are between 16-18%. Investing in mutual funds is a great opportunity on a long-term basis to reap decent gains. Unfortunately, even with average returns of *10-12%, once the inflation rate (generally 4-5%) is factored in, most families that invest are still paying out in debt more than they bring in through investments. There needs to be a balance in our finances. This balance provides a safety net of sorts for the rough circumstances of life and promotes a plan to give us the upper hand against debt.
How does it work?
America needs to get back to saving. Our desires to “have what we want now” are putting us on the tracks with the “6 month issue train” coming through. Stop the frivolous spending. I don’t understand how people who claim they are struggling financially go out to eat a few times a month. Families of four and five spend a hundred dollars easily on entertainment and food when going out, but wouldn’t survive a month if the primary breadwinner lost his or her job. STOP THE MADNESS!!! Why not save a couple thousand dollars in an emergency fund? (Preferably with your neighborhood financial institution). This creates an account that you can draw from when emergencies take place. When we do this, we eliminate the concept of financing bad situations that we relive every time we pay the bill. Next, we need to pay down our debt. Start with items that are in collections, back taxes and child support (if they exist). From there, a hard nosed, no non-sense budget should form. It’s not easy, but it’ll change your life.
But I’m already investing, should I stop and pay debt?
Earlier I mentioned the importance of understanding the interest game that is being played. If your creditor is getting 18% and your bank is paying you 2%, guess who’s losing? I don’t think it’s a bad idea if you have 401k and retirement plans already in place to continue. But think long and hard about how much money you give away and are not paying yourself. Also, what kind of investing do you engage in? It’s not my intention to give advice on the subject of investments, but there are many fees paid on certain types. That being said, take a look at the interest you’re paying in debt, the fees charged on the investments as well as your other debt accounts and then subtract your earnings on the investments. My guess is that you won’t make it to the bottom line without being annoyed.
The long and short
The reason people hang on to their savings instead of paying off debt is the same reason that we buy things when we can’t afford it. We are emotionally attached to ideals and reality cannot change our mind. We rationalize the fact that we pay bills to creditors because “our lives are already setup that way.” If we pay debt now from the savings it may hurt in the short term, but our ability to save will drastically increase in the long-term. Keep a couple thousand in the account, but pay as much debt off as possible so that you can save more.
There is never a cookie cutter solution to anyone’s financial problems. There are however principles that are resolute regardless of the issue. Being patient when purchasing is a fundamental principle. Find peace in waiting to buy things. Look for value and quality over the latest and greatest. What I propose is not something that can bought in a store, but is invaluable nonetheless. Most people I know are extremely hard workers, but I watch their efforts profit very little. We do need to save. We do need to pay off debt. But what we mostly need is to save ourselves from habits that cause the debt.