Personal Finance

Should You Save or Pay Off Debt?

If you have high-interest consumer debt, paying it off should be your first priority. Otherwise, no matter how well you do on your savings and investments, you're paying too much in interest expense to ever get ahead.

Say you work hard on your investment portfolio all year and consistently get a 10% return on your money. That sounds good. But if you're paying 12%, 18%, or more in interest expense on your consumer debt, you're still falling behind every year. And you can't even deduct consumer interest expense on your tax return.

Does that mean you can't even consider saving and investing until you're debt-free? Not necessarily.

Why you should start to save and invest immediately

There are several good reasons why you should start to save and invest now -- even if you're not done cleaning up all those old credit card balances.

1. Putting money into savings protects you from financial calamity

You can get out of debt without putting money into savings -- but you probably won't stay there.

If you don't maintain short-term and long-term emergency funds, the moment you need a major car repair, you'll go back to using the credit cards. And if some personal hardship comes along, such as a serious illness or unemployment, you can easily charge those credit cards back up to the limit in no time.

Don't think of your credit cards as your emergency fund. They're too expensive. As many people have learned in the last few years, the bank can cut back your available credit at any time. And worst of all, you have to pay it back.

Nothing provides a sense of financial security like having savings and investments you can use in an emergency.

2. Saving money is a learned habit

If you put off starting a savings program, you may put it off too long. Putting a portion of your income into savings every month is a habit, like brushing your teeth or exercising. The more you make it a habit, the easier and more natural it becomes.

Instead of waiting until you are completely debt-free before you start putting anything into savings, work on paying off your high-interest debt first. You may be able to transfer some balances to low-interest or zero-interest accounts. (But watch out for extra fees before you decide to transfer balances!)

So long as you have high-interest debt, getting rid of it must be your primary focus. However, putting even $10 or $20 into savings every month can help you maintain a healthy savings habit.

3. You can practice investing on a small scale

Read all the books and articles you want, but there's nothing like a few investing successes and failures to teach you about investing. You'll quickly find out how much risk is too much for you, and you'll develop your own style of investing.

Buying investments in small quantities is also a great way to rid yourself of any notion that the stock market is Las Vegas. The more you invest, the more you learn to ignore hunches and hot tips and to do your research before you make any moves.

Another great way to practice investing is to paper trade. Paper trading is simulating stock trades, on paper or through an online trading simulator, to practice your skills without risking any actual cash.

By the time you pay off your consumer debts and start investing serious money, you can be a seasoned investor.

4. Contributing to an employer-matched 401(k) type plan is too good to pass up

If your employer matches your 401(k) or similar plan contributions by 50% to 100%, by all means contribute up to the full match percentage. That's like getting a guaranteed 50% to 100% return on your money, which even outpaces the high interest rates on many credit cards.

5. Investing is fun

Investing is exciting, especially if you join a community of investors and keep up with investing news. It is infinitely challenging, and yet you can start having small wins right away. It has all the aspects of a good game, except the rewards -- and risks -- are real.

If you have high-interest debt, most of your energy must go to extinguishing it as quickly as possible. But don't let your debt balances keep you from starting to save and invest on a small scale in the meantime. If you establish good financial habits now, including putting money into savings every month, by the time you get out of debt you'll be ready to start saving and investing on a much grander scale.

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