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Each month we are faced with a lifelong dilemma. What should we do with the money we earn? While a wild spending spree might feel great in the moment we all know that if we want to achieve our financial goals we need to do something more with it. Yet, with limited funds it is hardto know whether we should pay down debt, save, invest, or some combination. How do you choose?
As long as you're in debt you will be paying more than you should due to interest. It is a slippery slope. Yet there is good debt and bad debt. A home mortgage is not bad debt like a credit card is. It enables you to own an asset that should appreciate over time (recent housing woes notwithstanding) and the interest is tax deductible. As long as you are not house poor there is no earth shattering rush to pay down your mortgage especially if you have other forms of debt and a small nest egg of savings. Another type of good debt would be student loans. Loans taken to better yourself and potentially increase your earning power in the long run are a good investment. These won't be your first order of business either.
We are all familiar with bad debt - credit cards and other "easy monthly payments" usually for things we don't need. Paying down debt should definitely be a priority and while it might not be fun, it is something that needs to be done. Whether you have a little or a lot, a flat out commitment and plan is the way to succeed. People tend to hide behind their debt, that is why it is so refreshing to see blogs like Me vs. Debt break the silence and start the conversation.
My take on paying down debt from personal experience is that you need to strike a balance. If you wait until you have all your debt paid off until you start saving money, you could be stuck in a rut for decades without any emergency savings or investment plan. Depending on the size of your debt it could take a few years to pay it down and let's face it, just because you decide to get serious about debt doesn't mean that "life happens" moments where you need to outlay a bunch of cash for a broken this or that or medical bills stop happening.
Saving vs. Investing
What is the difference? My personal definition is that savings are monies set aside, typically in a liquid account to pay for emergency expenses or planned big ticket purchases within a short time frame (generally under 5 years). Savings are things such as bank accounts, money market accounts, and CDs where your principal is guaranteed and you earn a fixed rate of interest. You don't have to worry about losing any of your principal (the money you initially invested) and for this security you earn a potentially lower rate of return than you might by investing.
Investing on the other hand is a long term strategy. It involves putting your money into vehicles such as stocks, bonds, and mutual funds. Your principal is not protected and you are essentially taking a higher risk in the hopes of a higher long term return than you could earn in savings. Over time the value of your investment can swing (sometimes wildly) above and below the value of your initial investment. Anyone who has ever watched the stock market blurb on the evening news knows that the markets can be volatile. Yet, over time past performance of investments has greatly exceeded what someone could earn in a savings account. In fact if you take inflation into account, savings accounts often do little more than keep pace with inflation. That is a risk (called inflation risk) all its own.
What Does That Mean for You?
The most important lesson you can ever learn is to pay yourself first. That's right no matter how much you owe to others or how much debt you are in, you must pay yourself first even if it is a seemingly insignificant amount if you ever want to move toward financial independence. You pay yourself first by setting up a savings account and creating an automatic withdrawal each week or month to fund your savings. In fact, if you act by March 31, 2008, you can
