Invariably, every few months, we get a wave of posts talking about “what would you do if you won $x,xxx,xxx?” Or, what you would do with a smaller windfall. And invariably, a majority of the people talk about how they would save the money. And in some cases they are right. But, most of the time, they are wrong.
Why are they wrong? Because they’re looking at saving from the wrong direction. I wouldn’t save a dime of it. I would use every last cent of it to pay off debt. And until I have no more debt, that’s what I would do every time. Sure, maybe I’d by a few things that I needed, but the rest goes to debt. Saving in a savings account doesn’t do you damn bit of good if you have debt.
If you have any debt at all, you really should think twice about having any savings at all except for an emergency fund. Why? Because, there is no savings account in the world that will guarantee you more interest than what you are paying on your debt. If you pay off $100 of your credit card debt, you’ve just earned the 19% interest that you would have paid. You “saved” more with that $100 than you would have in years if you had put it into a savings account.
Don’t fool yourself into thinking you need to have anything more than an emergency fund in the bank. All the rest is just money that could be making you 19% interest instead of the paltry 1.30% that you’ll get at that high-yield online savings. When you get rid of your debt, then is the time to start building your savings!
Some of you will likely ask “what about retirement savings?” That’s a gray area. There are some that would argue that if you don’t get that debt paid off, you’ll end up taking that money out early anyways. Others would argue that due to the tax benefits of retirements accounts, and the magic of compound interest, you really should be putting money into your retirement too. My current opinion is stuck somewhere in between. I think that you should be putting a little into retirement, just so you have something going. But, I also think that you should keep in minimal until your debt is gone and then ramp it up like gangbusters.
So, what would you do if you won $x,xxx?
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Great way to look at it but I think you have to be careful on not going in with blinders on. If you know that you’ll need to replace your car in a few years, you might want to ‘save’ some of your money so that when that time comes, you’re able to pay cash and avoid going right back into the cycle of debt.
High interest debt, I agree, should be paid as quickly as possible. But, if you can eliminate the credit card debt and are left with lower interest debt like mortgage, student loans, etc., then I think you have some opportunities for a balance.
Personally, we have a ‘rule of 25%’ where 25% of any amount coming in other than pay goes to debt. Because all of our debt is lower interest, this allows us to save for the new roof we’ll need in a couple of years, the new car we’ll need in five or six years, put money for current car repairs, put money in the college fund, and do a little mini-vacation each year.
Good advice as long as the cost of debt is higher than what you could earn over the time it takes to pay it back. Long run, you should be able to earn a rate of return in the market that is more than say what you pay on a mortgage and probably on student loans and auto loans . Agreed on the credit card debt. By paying it off, you’re basically earning 19 percent less the rate you are getting on your savings. Pay that stuff off.
I sort of agree….but not fully.
We have our emergency fund. And we have our ING accounts for saving for camp, car stuff, etc. And we have a “savings” account that is linked to our checking account. We use this account as overdraft protection incase of a mis-step, and just as a cushion in general. We do continue to contribute to it via direct deposit.
I clear out the savings account and pay down debt, and it would feel great! But if something got messed up in our budget, I would not want to touch the emergency fund because I screwed up….that is for true emergency. I feel more secure knowing I have a buffer.
I would caution against making the emergency fund too small when you are battling debt. I once was attacking debt with every penny, and I decided that saving 20% interest was better than earning 0.5%. I then lost my job and had to live off of credit cards because I didn’t have an emergency fund – a small one would have helped, but I needed a few months of living expenses (reducing my spending helped some).
I would say to have at least 1 month saved before fully attacking debt…more if you need it.
I agree. It doesn’t make sense to save $100 and keep a $100 balance on a 10+ credit card debt. It’s ridiculous.
Best to do both and make sure you are liquid!
In my opinion saving is always good. But saving is not enough. We should simultaneously save and make money by investing. Thanks for your insights.
I agree with your thinking. Another way to help clarify why to pay off debt instead of keeping money in savings is to ask yourself this question: “If I had zero debt and zero savings, would I borrow the money to put in a savings account?” Most people intuitively know this is not a good idea, but keeping the debt while keeping the savings is the same thing. This being said, I agree with Khaleef that you should have a small emergency fund while paying off debt and then a bigger one as soon as the debt is gone.
I agree with this, too. I would definitely pay off the high-interest debt first. As for the low-interest debt, it would depend on risk vs return. If I won a bunch of money, I’d probably get rid of the home mortgage if for nothing else than peace of mind that at least I own my own home free and clear.
At this time, the whole lot of it would be invested in my Vanguard index funds. Easy peasy and earning some healthy interest rates at the moment.