Save, Invest, or Pay Down Debt?

As a millennial financial planner and money manager, I’m constantly getting questioned about what to do with the extra money left after all those bills are paid. Do I just save it? Should I pay off debts? Should I start investing it? All three are very important, yet unique to each individual. All three are great options in and of themselves, but what option is best for you? It’s important to assess your personal situation, after doing so you can lay out clearly defined goals for your financial future. By learning the benefits of each option and strategies for approaching them you can start making better decisions.

Saving:

Why would I save money if I have a mountain of debt to pay off? The reason is simple, EMERGENCY FUND. Emergency funds are crucial to any successful financial plan. Rule of thumb is to keep 3-6 months of savings to cover your living needs. If you lost your job or were faced with an unforeseen situation, emergency funds are essential. Not only will it help cover all of your basic living needs for 3-6 months, it will help reduce the stress of facing an unforeseen situation when it arises.

Successfully building an emergency fund while you have other obligations can be difficult. Try to start saving 10% of every pay, this is a suggested starting point, but start with a percentage that works for you. The point here is to create a routine around saving small increments, eventually this will become habit. I’ve coined this, ‘unconscious savings’– a process in which you save money without having to think about it. Open a separate savings account or brokerage account with a checking feature. Have your employer direct deposit your savings into this separate account. The remainder of your pay goes to your existing checking account. You will be surprised how quickly your savings will grow when it becomes an automatic habit. Remember this is an emergency fund, so don’t go digging into it for unnecessary expenses.

Invest or Pay Down Debt?

After having built up your emergency fund, it’s now time to decide how you want to tackle any outstanding debt and/or start your investment strategy. Remember the 10% you were saving for you emergency fund? Now we can use that money to start investing and/or paying off debt. Your savings habit will make the transition from saving to investing/debt reduction seamless and will put your money to work immediately.

We’ll start with debt. Always, always, pay off the debt with the highest interest rates first. By prioritizing debt, you can save yourself a lot of money over the long term. Credit card debt generally will carry a very high interest rate. These interest rates will compound making the amount you owe back more and more the longer you wait. Therefore, try to forgo accumulating any high interest debts; if you do make paying them off a priority. I would consider anything over 10% a high interest rate you will want to pay off first. Make yourself a priority list of what debts you’d like to pay first.

Deciding to start investing will be much easier, if you aren’t carrying much debt, in this case, kudos to you! However, if you have long term debt, with reasonable interest rates, investing still may be a good idea. The question you need to ask yourself is this: Will investing generate a rate of return larger than the interest rate on the debt you are carrying? If you’ve answered ‘YES’, then investing rather than paying debt is a good option.

Does your employer provide you with a 401(k) plan? Start there! If your employer ‘matches’ a portion of your savings, great, you just got paid to save! Outside of a traditional 401(k) I would suggest exploring other IRA’s, either traditional or ROTH. Both have their benefits, conduct your own research on both and ask your advisor to help choose which is best for you. In the event you have saved enough to max out those options, then open up a brokerage account, online or with an advisor. We can talk about all of these options in future posts, so stay tuned.

Things to keep in mind, only paying monthly minimum payments could impact your credit score. Be cognizant of your credit score and manage it accordingly. Talking to an advisor or a mentor can help with this process. By nature, investing involves an element of risk, thus you do have the potential to lose money. Knowing how to properly invest given your risk tolerance is important, again we will talk about this in future posts.

In closing, start building that emergency fund now. Save unconsciously by automatically depositing your savings into a separate savings account. Once you’ve built up a level of savings you are comfortable with you can start tackling any high interest debt. Then start investing and/or paying off some additional debt.

I would make a general recommendation that if you have some low interest rate debt, and you are in your 20’s, start investing now. Consider all of your options and develop a strategy going forward, remember to revisit your plan and make changes as you grow. You will be glad you started young, compounding savings and investing, while paying off debt, will prove invaluable later in life.