Debt Consolidation

The Facts About Debt

Save or Pay Debt

Filed under: Debt Consolidation
Written by: UWSA Staff
October 21, 2008

What makes more sense, paying down debt or saving for retirement?

Especially in today’s climate where many are seeing their retirement savings reduced by the falling stock market, and the debt level of the average American is approaching all time highs, many are faced with a question; should I pay off my bills or put more into savings? There’s a bit of math to really answering this question, and some other considerations, which can affect the answer.

The kind of debt

First let’s consider the kinds of debt we could be talking about. For some a hundred or so thousand in student loans seems like an immense amount of debt. In truth though a twenty thousand in credit card debt could affect your financial situation a lot more dramatically. You can write off interest on student loans, you cannot on credit cards. Further because of the fees and revolving nature of credit cards they can amount to thousands more in costs over a long period of time. With low interest, non-revolving debt it can make a lot of sense to invest as well especially when you factor in the tax advantages of many savings programs, and ability to get ‘free money’ in the form of an employer match, or other tax advantages investing incentives.

The Interest Rate

Much of this also requires a look at the interest rate. Even assuming a rate of return on your savings of as much as 12%, which is what the S&P 500 has averaged since 1926; if you’re paying 25% to your credit card company you’re losing money. In fact if you’re getting 12 percent your money about doubles about every 6 years, while at 25 percent your credit card company is doubling the money they lent you about every 3.6 years, and that’s assuming that you’re not charging it back up!

The kind of savings

Even if you don’t actually have any debt you could still be losing money. Inflation averages 3 percent historically and recently it’s been as high as 4.1, excluding increases in gas and food prices. If your investments are not keeping pace with inflation you’re losing buying power; essentially you’re not making any money, and possibly losing it. This is called inflation risk (as opposed to market risk; when the market goes down, which is what many novice investors tend to think about). So say you’ve got an investment averaging 12 percent, and a 9 percent interest credit card. You could still be in effect losing more than 1 percent of the buying power of your money.

How long until you retire?

Bottom line saving is about the math as much as it is the risks. If you are already nearing retirement you may not have enough time for your savings to begin growing enough to outpace the debt you are paying off. Young investors however may be able to afford more investment risk, ideally for a higher return, and out pace the costs of debt. Either way however debt is eating money every month or that’s extra money you could be saving.

Summary

You have to really look at your projected, as well as historic, rate of return on your investments and compare those to what you’ll be giving to the companies, which hold your debts. There are several on line calculators that can help you accomplish that. If you’re up to your ears in debt and haven’t started saving it’s time to get serious and look at ways to eliminate your debt quickly such as debt consolidation, or debt stacking. To be truly saving you have to be saving more money than you’re losing, and the bigger the difference between the two the faster your savings will grow which is critical to retiring well.

Similar Posts:

No Comments »

No comments yet.

RSS feed for comments on this post. TrackBack URL

Leave a comment