“Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like.” –Will Rogers
Boy, oh boy, did Will nail it on the head with this quote. Debt affects a lot of Americans. We live in a society where debt is a way of life and easy to obtain–and therefore can quickly get out of control. I meet with a lot of individuals who want to learn the best way to pay off their debts while saving for other goals at the same time. Of course, the answer to this question is different for everyone, but a good rule of thumb is that you need to do both. Let me explain.
When working on debt reduction, most individuals lean toward putting all their extra cash toward additional debt payments, thinking this is the fastest path to becoming debt-free. And sure, it certainly feels good to see the immediate gratification of your debts going away in large chunks at a time. But when you take all your available cash and make additional debt payments, you remove the ability to save any of that money and build up your emergency fund to a healthy level. (Watch my video “Build a Cash Cushion” to learn more). Without an emergency fund to cover the unexpected expenses that always come up in life, you may end up using the same credit card you’ve been working so hard to pay off to bail you out. It easily becomes a catch-22.
So instead, split up your excess cash and allocate some toward making extra debt payments and some toward building your emergency fund. By following this strategy, you will slowly begin to untangle yourself from your debt and build the financial foundation you need to cover you when life’s unexpected events inevitably occur.
Here’s an example:
You have $500 left over every month to save or use toward debt reduction. You may simply divide this in half, add another $250 toward additional debt payments and put the remaining $250 into your savings account. This way you’re building up your emergency fund while still paying down your debt. Of course, working with a financial planner will confirm a suitable allocation breakdown for you and your goals.
Continue reading about debt reduction strategies: Which is the Better Method for Reducing Debt? Snowball Method vs. Avalanche Method