The decision to pay off debt or save for the future is a decision many of us have either faced in the past or are currently facing. As a financial advisor, I’m always quick to point out the long-term benefits of investing as early in life as possible. However, when it comes down to an either/or decision of paying off debt or investing, my answer quickly shifts to “it depends”.
As tedious as it sounds, writing a budget is essential for everything that follows. Take an hour to gather all your expenses for the last few months to get an idea of where your money is going and how much disposable income you have available. Once you’ve established a budget, a quick 15-minute review each month is more than enough to keep yourself on track. This can be done the old-fashioned way with a pen and paper or a budgeting app like PocketGuard, Mint, or YNAB (You Need A Budget).
Since we did a budget in step 1, we know how much disposable income we have available to apply to the debts. Let’s say we have $1000 available after all expenses and making all our minimum payments above. We take that $1000 and apply it to the credit card. The credit card is fully paid off in month 2, so now we take that $1000 plus the $25 credit card payment and add it to the $50 we’re already paying to the personal loan. The personal loan is fully paid off in month 4 and we roll all those payments to the car loan and by month 11, the only debt remaining in the student loan, and thanks to the snowball effect, we’re now paying $1775/month towards the student loan ($1000+$500+$200+$50+25=$1775). With this aggressive approach, you’ve paid off over $40,000 of debt in roughly 2 ½ years!
5. Save for Retirement
Now things get fun. The only debt you have at this point is a mortgage. It’s likely at a low rate and should offer you some tax benefits, so continue making your minimum payments.
You should now strive to contribute as much as possible to your retirement. This can be done either through your employer’s retirement plan or through a Traditional or Roth IRA. This is the point that I would recommend most people reach out to a Certified Financial Planner™ professional to assist them moving forward. Not only will a CFP® professional be able to help you determine how much to save for retirement, but will also be able to assist you with all other aspects of financial planning: investment management, college savings, estate planning, insurance, etc.
So, there you have it, a relatively simple 5 step approach to get your financial house in order. Keep in mind that reaching step 5 is just the beginning of planning for your financial future but the sooner you can reach step 5, the more likely you are to be successful with your finances moving forward.
Brad Lupkes, CFP®