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Investing vs. Paying Off Debt: 6 Rules to Follow

Personal Finance

You know you need to pay off debt. But you also know you need to save for emergencies, education, a house and retirement.

A man typing on his phone while looking at his diary.

There’s only so much money to go around, however. And, if you try to pay off 100 percent of your debt before you start to save, that could a really long time.

At the same time, if you put money into savings at the same time you’re paying high credit card interest rates, you’ll never get ahead either.

So, what’s the best plan?

Follow these six rules to help you decide how to prioritize your savings and debt repayment plans.

1. Your emergency fund comes first.

You can get out of debt without putting money into savings, but you probably won’t stay there.

If you make just enough money to pay your bills, and you have nothing set aside for garden-variety calamities in life, you’re almost certain to go into debt the next time the car dies or you need dental work. What other choice do you have?

Try to keep one month’s salary in a savings account or other accessible place, so you know you can cover minor emergencies when you need to.

Whenever you have to dip into the emergency fund, save like crazy to pay yourself back. Tweet this

Once you get used to having an emergency fund, you’ll wonder how you ever slept at night without it. Work on building your fund up to three or six months’ worth of living expenses.

2. Credit cards are not an emergency fund.

Credit cards charge way too much interest to make good substitute emergency funds. Plus, your credit limit could be pulled at any time. Then what would you do?

Plus, if you hit financial hard times, the last thing you’ll want to do is go farther into debt.

Credit cards make fine payment tools, but they’re lousy long-term loans. Tweet this

3. Some debt is okay; some debt is toxic.

It would be wonderful if we could live without debt, but that’s almost impossible these days.

If you tried to save enough money to buy a house, home prices would probably rise faster than you could tuck money away.

However, mortgage debt is often deemed “okay” debt because it usually has low interest rates. Plus, if you can resist refinancing, the balance usually goes down over time.

Additionally, mortgage debt is tax deductible for most people.

When it comes to other loans, their severity varies.

Student loans should more than pay you back with a lifetime of higher earnings and a satisfying work life. And, like mortgage loans, the interest rates are low.

Car loans, furniture and carpet payment plans should all be paid off as quickly as possible in most situations. The same goes for credit card debt and delinquent bills.

Basically, if a loan has a high interest rate, it can be toxic to your financial life.

When you think about paying off debt vs. investing, concentrate on paying off the toxic debt first. Tweet this

The best form of action against your debt is to make a list of your debts and prioritize them.

4. The most important ingredient of a savings plan is time.

If you don’t have retirement, savings or investment account, consider opening one today.

Starting a 401(k) plan in your 20s or 30s makes it easier to be ready for retirement when the time comes.

If you wait until you’re 50, it’s going to be tough.

Not only is it harder to save that money in a shorter period of time, but you miss out on giving our money time to compound over your working lifetime.

The wealth-building phenomenon known as compounding allows your money to grow over the years because each year’s gains (returns) generate their own gains the next year.

That’s why you should open accounts and start saving as early as possible even if you can’t save much. Every little bit helps!

Before you pay off all your debts, pay yourself first. You can’t afford to wait. Tweet this

5. Never leave employer-matching contributions on the table.

Take advantage of an employer-matching plan at work if your place of employment offers one.

In many cases, an employer matches 50 percent of their employee’s contributions to their 401(k) plan, up to a limit. If you’re extremely lucky, some employers match 100 percent.

No matter what percentage your employer matches, make your plan contributions and take your matching share – even if you still have consumer debt. It’s too good of a deal to pass by!

6. Take the time to prioritize.

The question isn’t whether you should pay off debt or start saving first. You should get in the habit of saving even while you climb out of debt.

Instead, the question to ask yourself is how will I prioritize my finances to meet my savings and debt reduction goals?

To start, it’s quite basic. On the debt side, pay off credit cards and delinquent bills. When it’s comes to your savings, create an emergency fund.

And, if your employer matches any percentage of your 401(k) contributions – take it! Don’t be afraid to open retirement or investment accounts. Even if you can only contribute a small dollar amount per month, that’s better than contributing nothing at all.

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