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This is a huge conversation in the personal finance world and one that really has to be personal when it comes down to it. If you’re a Dave Ramsey follower, then you know what the answer would be. But, if you’re someone that has made your own path navigating your finances, then it can take a bit more thought.
I personally come from a view of creating long term goals and then short term goals to reach those goals. I know for me, following the baby steps just won’t get me to my long term goals. Not as fast as I’d hope anyway.
My end goal is to reach FIRE, not necessarily to retire, but to have the freedom to do whatever work I want, regardless of pay. Right now I’m stuck at my job solely because of my debt and grants I received from my undergrad and grad studies.
These are the steps I followed in order to create a plan for myself in regards to paying off debt or saving.
1. Create long term goals.
Think about big picture, where do you want to be in 20 years? When do you see yourself retiring? Where do you see yourself working? Do you have any goals you want to reach that are impacted by your financial status?
Once you know your goals and have them written out, it will make it so much easier to figure out your financial plan based on those goals. Everyone has different goals, so everyone’s financial plan should look different. This is why I don’t really agree with the baby steps. Yes, his steps work, but only if you have that specific goal in life and you’re life aligns with the steps.
For me, I had $200k in student loan debt and I’m in my 20s. You’re crazy if you think I’m putting off saving and retirement for as long as it’s going to take to pay off my debt. This is why it is so important to think about your specific goals and what helps you to reach those goals.
2. Create short term goals.
Once you have your long term goals mapped out, create short term goals to reach your long term goals. For example, my long term goal is to reach FIRE. My short term goal I am working on is to pay off my private student loans and then my high interest Federal student loans. Once that is done, I will be increasing my savings and retirement contributions, while I pay off my lower interest student loans.
You have to think about what you need to do to reach your long term goals. Depending on what your goals are, everyone’s short term goals will look different. Take the time to really think about what makes the most sense for your long term goals and don’t be afraid to change them as you get closer to reaching your long term goals. For example, originally I wanted to pay off all of my debt, but then I realized that some of my debt has such a low interest rate that it would do better in a retirement account.
You just need to make sure that your short term goals are realistic to reaching your long term goals. As you move through the process, make adjustments as necessary. Life changes and things happen that we can’t expect. It’s important to make adjustments in the ever changing seasons of life.
3. Adjust your budget to reflect your goals.
Once you have your goals written out, you need to update your budget to reflect your goals. No matter where you are in your journey, you need a budget to reach your goals. Without a budget, you won’t know where your money is going or where to send it. What I mean by this is, even if you have no debt, if you don’t tell you money where to go for investment or savings goals, it will just sit in your account. If it’s just sitting in your checking account it isn’t working for you when it could be.
Create your budget to align with your goals, I would suggest zero based budgeting to make sure you are accounting for every penny. I have Google sheet templates available to purchase, if you need help with this!
Personal finance is personal and you ultimately need to decide what is best for you.
There is a one size fits all answer for this. I am definitely not saying debt is good, but depending on the interest rate and your long term goals, it may be mathematically smarter to contribute more to investing and less to debt. You need to take the time to really think about what your goals are and what you want for your life. Once you have that figured, you can create a plan that gets you there.
FAQs
Smart money moves when saving
One of the key advantages of saving before paying off debt is the concept of building a financial safety net. An emergency fund, for example, serves as a financial cushion, shielding you from unexpected expenses, job loss or medical emergencies.
Should I save money first or pay off debt? ›
Smart money moves when saving
One of the key advantages of saving before paying off debt is the concept of building a financial safety net. An emergency fund, for example, serves as a financial cushion, shielding you from unexpected expenses, job loss or medical emergencies.
Is it better to pay off debt or build an emergency fund? ›
On one hand, paying off debt could save you thousands in interest. On the other hand, failing to build your savings could force you into further debt if you encounter unexpected expenses. Generally, building an emergency fund should be your priority.
Is it better to pay off debt or put money in a 401k? ›
Key takeaways
If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement. This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
Is it better to pay off debt or have a bigger down payment? ›
If you're not focusing on paying down debt faster, you may pay for it in interest charges on your outstanding balances. It won't help your credit. Although a larger down payment can make it easier to qualify for a lower interest rate, it won't help much if your credit scores are being dragged down by high debt.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
Is $30,000 a good emergency fund? ›
Most of us have seen the guideline: You should have three to six months of living expenses saved up in an emergency fund. For the average American household, that's $15,000 to $30,0001 stashed in an easily accessible account.
What is the fastest way to budget to get out of debt? ›
Many experts recommend using the 50/30/20 budget for getting out of debt. This method has you earmark 50% of your net income for just essentials—that's things like housing, bills and basic groceries. Then, you allocate 30% toward discretionary spending and the remaining 20% toward savings and debt repayment.
What is an emergency fund Dave Ramsey? ›
An emergency fund is money you set aside for life's unexpected expenses, like car repairs, hospital visits and even job loss. This money gives you the power to hand over cash to cover the big and small surprises that come your way.
Do millionaires pay off debt or invest? ›
Millionaires typically balance both paying off debt and investing, but with a strategic approach.
This budgeting rule states that you should allocate 50 percent of your monthly income for essentials (such as housing, groceries and gas), 30 percent for wants and 20 percent for savings.
What are the disadvantages of paying off debt? ›
Whether you're paying off a loan with a lump sum or you plan to chip away at it with larger payments, paying off your loan faster will likely mean tightening up your budget. Consider where you'll get the money to pay off your debt — is it being diverted from your retirement savings plan?
Is it better to pay off all debt or save money? ›
While paying down high-interest debt will help you reduce the amount of interest you owe, not having an emergency fund can put you deeper in the red when you have to cover an unexpected expense. “Regardless of [your] debt amount, it's critical that you have money set aside for a rainy day,” Griffin said.
Is it better to pay off big debt or small debt? ›
You might end up paying more in interest than you would have paid if you tackled your highest-interest debt first, but the psychological benefits of getting those smaller debts paid off as quickly as possible can be very rewarding.
Is saving money worth it? ›
Achieving Financial Goals: Saving money is instrumental in achieving both short-term and long-term financial goals. Whether you're saving for a down payment on a home, a dream vacation, or your child's education, setting aside funds regularly accelerates your progress towards these milestones.
Is it better to pay off debt or let it fall off? ›
In general, paying off your credit card debt in full is the optimal solution that preserves your credit score and history. However, it may not always be feasible to afford paying the total balance owed, especially with high interest rates compounding the problem.
Is it always better to pay off debt before investing? ›
Investing makes sense if you can earn more on your investments than your debts are costing you in terms of interest. Paying off high-interest debt is likely to provide a better return on your money than almost any investment.
Should I pay my highest debt first or lowest? ›
The avalanche method can save you both money and time. Chipping away at your priciest debts first reduces what you'll pay in interest in the long run. In turn, you can use the savings to help pay down what you owe and speed up the repayment process.
Is it worth paying off debt early? ›
Almost every type of loan can be paid off early, and there are many benefits for doing so. It can save you money. It can improve your credit score (though not always). It can provide peace of mind.
