Should you be saving for rainy days or paying off debt?

0
Placeholder while loading article actions

You don’t have a lot of money.

You may be wondering if it’s better to save it for an emergency or to pay off a debt.

This decision can send some people into financial paralysis. They don’t know what to do, so they don’t fully commit to either choice.

But consider this: A Federal Reserve report on the economic well-being of American households found that 40% of survey participants couldn’t cover a $400 emergency expense. To raise funds, people said they had to sell something or borrow money.

How to pay off your credit card debt

Here is a question on the savings vs debt debate that I recently received from a reader during my weekly online chat.

Q: I am pregnant with my first child. I moved in with a friend at the end of last year to save money and pay off my debts. My moving schedule has changed due to my pregnancy. I saved to pay off a 401(k) loan. I wonder if I should repay the loan or keep the money in my savings account, just in case, due to my imminent new arrival. I will be out of work for four months of paid vacation. But I will have to make these payments every two weeks for the loan while on maternity leave.

Thank goodness for paid vacation. Even so, the birth of a child can blow your budget more than expected. I wouldn’t use up savings to pay off the 401(k) loan. Simply continue to make payments from the income you will receive while on leave.

It’s hard to see money sitting in the bank and barely earning interest. But your emergency jar is there for a purpose. You always need a rainy day fund because it always rains. It could be a drizzle or a heavy downpour.

That’s why every dollar of your income should have a destination. I try to make people understand that their emergency savings are not money for growth. It’s not like your retirement account, which has to grow to keep up with inflation. The purpose of your bad weather account is to save you from having to sell things or borrow when you have an unexpected expense.

You must have savings even while getting rid of your debts. If you don’t and a crisis hits, you’ll end up getting into more debt or bothering your friends and family for money. And believe me, I’ve heard a lot. They’re sick of you hitting them.

So you’re asking the wrong question when you ask whether you should save or pay off debt. You should ask yourself: how much should I have in savings if I am deeply in debt?

To arrive at this figure, first consider your job stability. Is your job secure?

If you’re not sure your job is secure, you’ll need money to help cover your expenses while you look for a new job. Debt matters, but a roof over your head and other necessities of life take priority. You may think you’ll find another job quickly, but what if that doesn’t happen?

This credit card error can cost you dearly

Even if you’re confident your job is secure (or as reasonably secure as any worker can be these days), put any plans on hold to save the recommended three to six months of living expenses. You should definitely aim for this eventually, but not now. Instead, save just enough to cover typical emergencies that come up frequently, like a major car repair.

A comfortable emergency fund for most people is probably between $1,000 and $1,500. Once you’ve reached that goal, stop saving and use any extra money you get to tackle debt.

If your circumstances change, such as if you have an unplanned pregnancy or there is a legitimate possibility of layoff, slow down or put your aggressive debt reduction plan on hold.

It’s great that the reader wants her 401(k) loan paid off as soon as possible, but the pregnancy creates a higher financial priority for now. She must have money “just in case”.

What if there are complications and she has to take unpaid leave? What if a roommate with a baby was more than her friend bargained for and this new mom had to look for another place to live?

The answer to your question of whether you should be saving or paying off debt is that you need to do both.

Early retirement is doable. Here’s how.

Could you live off Social Security alone?

The number of 401(k) millionaires hits a new high

Share.

About Author

Comments are closed.