Priority One: Saving Or Paying Down Debt?

Priority One: Saving Or Paying Down Debt?

Sunday, January 17, 2021

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It should come as no surprise that for many people across the world, the number one money move they identified for 2021 is saving money. With good reason: The sudden health crisis rendered by the novel coronavirus and the subsequent pandemic found people constantly raiding their emergency savings, only to find they were woefully inadequate, or, unfortunately in many cases, non-existent. According to a recent study, nearly 14 per cent of Americans have wiped out their emergency savings since the pandemic.

The truth is that although everybody always advises about having an emergency fund containing three to six months' salary, nobody ever really expects a six-month emergency. Let alone a nine-month one. Which presents another existential problem: With subpar savings, many people were forced to turn to their credit cards to deal with the mounting expenses, thus pushing them even deeper into debt than they already were in. Those who could, have started to tap into their investments, by taking profits, encashing or reliance on dividends.

The question now becomes should they save money and put off repaying debt or pay down debt and wait to begin saving again?

This is a conundrum Jamaicans, too, are facing. There are indications that a return to some semblance of normalcy within the economy is imminent. Let's say your furlough is over, you're back on full salary, or even that you were one of the fortunate ones who received a cash incentive at Christmas. Or perhaps you've freed up money from areas of your budget, say, entertainment, since social distancing protocols are still very much in place and social events are practically cancelled. At any rate, your financial situation has begun to look up. What to do with your improved financial outlook: Save or pay down debt?

The case for prioritising saving

The answer may be more nuanced than you believe. Conventional wisdom would perhaps favour paying down debt as the priority. After all, isn't debt nothing but a financial burden that interferes with your ability to save in earnest? While this is often true, especially if the debt carries a high interest rate, consider these reasons for making saving your priority:

• Your emergency savings fund needs to be replenished pronto — the sooner you start the better off you'll be to take advantage of compound interest. The more time your money has to compound, whether in a CD, savings, money market or investment account, the more it will grow for you. If another emergency pops up down the road this will help you avoid accumulating new debt. Further, nothing will beat cash or cash-like reserves in the event of an emergency.

• Your debt, if it has a low interest rate, can give you breathing room to not feel as though it's this huge financial burden, thus giving you some peace of mind. If the net financial results of saving plus interest is greater than those from the reduced interest on the debt, this will obviously be a plus.

Prioritising paying down debt

Your debt repayment strategy will of necessity be based on the type of debt you're carrying. If your debt is primarily student loans, you have the option to defer payments, etc. But, let's say it's credit card debt. A high-interest credit card can be stress-inducing when the balance doesn't seem to be going down, which will happen if you're only paying a minimum payment every month. These are a couple of advantages to paying down debt first:

• You will reduce the amount of interest, especially on high-interest cards, by paying off debt quickly. This can put you in good stead when it comes on to improving your credit ratings when the time comes for buying a home.

• With this mental weight off you, freeing yourself to focus on saving as well as accomplishing other financial goals like investing. You should also consider refinancing options given the low interest rate environment we are now in. Pay off high-interest rate credit cards with a lower rate line of credit.

Striking a balance

But there's a third, perhaps more ideal, option that should also be considered if you're still unsure of which of the previous two is most suitable for you: Split your disposable income between saving and debt repayment. In Jamaican parlance: Ride and whistle.

First, you have to consider the big financial picture.

How do you decide what's the split? Depends on what your emergency fund goal is vis--vis your debt. Whichever is the higher priority, that's the one you'd put more money towards. So, let's say you have an extra $50,000 kicking around and you have high-interest credit card debt which uses compound interest against you, then you might want to pay $30,000 on the credit card per month, leaving $20,000 available for saving. Or vice versa if your debt is low-interest, putting $20,000 towards debt and $30,000 to saving.

But this is just a simple example meant to underscore the possibility of doing both. For an analysis of your individual situation, however, employ the services of a financial advisor to help chart your course to financial freedom. Remember, carrying long-term debt is not an ideal scenario because it can end up costing you more money in the end, deferring your financial goals. But neither do you want to wait to save, either, as this can significantly lower the amount you accumulate over time. The best approach may be one that allows you to smartly do both at once.

You can benefit from both paying down debt and building an emergency saving fund simultaneously.

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