Figuring out what to do with your income is fundamentally what budgeting is all about. If you don't have consumer debt, the choice, once you've accounted for expenses and charitable giving (including tithes), the money is either saved or invested. Just put the money to good use working for you.
If there's a $15,000 credit card balance in the mix (with a minimum $600 payment if the amount due is at least 4% of the balance) then things get more complicated. Let's say for example that there's $1,000 per month after (reduced) expenses. The first $600 goes to the debt, and the other $400 goes to what? To savings, or debt reduction, or investing?
I'd suggest that nothing go toward investing. Saving up an emergency fund and paying down that debt should be more important than contributing to an IRA. (Dave Ramsey teaches this, too.) The reason for this is that the debt is a huge hole in the bucket. Investing would pour water in the bucket, of course, but if the bucket is draining faster than it's filling, there's a problem.
If an emergency fund is in place (say, $1,000) then the $400 should go toward reducing the debt and plugging up that hole. If there's no emergency fund in place, the money should be put into a savings account until it's built up a bit, then the debt should be attacked full force once there's about $1,000 in the emergency account.
How much should you put toward emergency fund and how much you put toward debt reduction in these early stages of debt reduction? It may be a matter of taste, but I'd do a little bit of both at the beginning: maybe $300 toward the emergency fund and $100 to knock down the debt a bit. Why? Even if the emergency fund isn't meant to be touched, it's there, and there is that temptation to dip in. Paying down the debt a little bit is a bit more permanent (as long as the credit cards are well out of reach) and if the emergency fund is dipped into and goes back down to nothing, at least there will be some progress made on the debt reduction. If all of the money had gone to the emergency fund and the temptation was too much, then it's back to square one.
Once that hole is finally plugged up (like No Credit Needed did a while back, and Debt Hater, a member of his network, did recently), then it's time to invest in that IRA, 401(k), save for college, etc. Now the bucket can be filled without the hole. That's very important.
I've never had debt other than mortgage or loan for my very first new car bought in 87; bought subsequent cars for cash. So I don't have much experience with debt. I also have math background (CS).
For these reasons, I don't understand the advice of putting money in emergency fund instead of putting every cent toward repaying high interest consumer debt. It just doesn't make sense mathematically. Let's compare two cases: A. you pay $1000 toward credit card debt today, you don't pay the interest on this $1000 starting now. Two months from now you have an emergency that requires $1000. Since you don't have emergency fund, you put this $1000 back on your card. So you added $1000 that you paid off back to your debt, but you've saved 2 months worth of interest on this $1000. Case B. you put $1000 to the emergency fund instead. So you have $1000 in the bank earning 3% after-tax and you also pay double-digit interest on the same $1000 on your credit card, so you are essentially losing money every month. 2 months from now the emergency happens which you pay from your emergency fund. But you still have a larger debt than in case A because of all the interest that acrued on this $1000.
No matter how you slice it, it doesn't make sense to earn 3% or even 5% (pre-tax) in the bank while paying a much larger percent on the debt – whether you call it "savings" or "emergency fund" it still doesn't make sense. Now if one is paying 0% on CC debt it is quite a different story…
I think it's important to have an emergency fund, not becase of the math, but because of the phsycology of it. Once you take out that credit card to pay for something it's easier to keep using it. If you just put it away and only use cash you won't build up any more debt.
I'm in a position now that I've paid off all my credit cards and my car loan, have an emergency fund, but still have a rather large loan I took out awhile ago to consolitate all my debts. My advice on this…don't do it, not unless you've cut up all your credit cards, or you will still create more debt.
Anyway, I'm having a very hard time paying off this loan. I'd like to pay it off early but can't seem to find any $$ in the budget.
My income has gone down about $9000 this year, no more child support and no more overtime, and my expenses, like every one elses have gone up.
I'm wondering if I should stop contributing 10% to my retirement account and go down to the 5% that my employer matches until this debt is paid.
Any comments on this idea?
Being adverse to debt, I like the idea of paying off any debt before contributing to savings or investments. I can see how building up an emergency fund at the same time as paying off debt can be a good strategy for people who are used to living with debt. Personally, if I needed to, I would use Kitty's strategy of falling back on a credit card rather than an emergency fund.
I feel a moral obligation that if I owed someone money, they would get first dibs on my income before I could invest it for myself. That's a huge incentive to stay debt-free.
I think it is important to pay down debt, save for the emergency fund AND put money into "investing" or earmarked for investing at the same time. Do them all at the same time, no questions asked IMHO.
It isn't 50-years ago when there were 3 broker-dealers and to buy shares of AT&T you needed to pay hundreds of dollars in commissions…In today's day in age, you sign up with Zecco, TradeKing, ING/Sharebuilder and send off $1 a week if that is what you can afford and create the habit of saving and investing for your future! Link up the checking account to your discount broker and pay yourself as little as a few bucks a week and snowflake into the investing account. Let that money sit in there until you have a solid amount (say $250-500 depending on the commission) and then buy an ETF like the Vanguard Totals Stock Market Index with 1,000+ companies…
And as far as not saving into an IRA, you get ONE year to save into your IRA. You don't get to go back to 2006 and add in a few hundred dollars. Once the year is gone, it is GONE! So snowflake into an IRA as well and let the money sit in there in the Money Market account until you can buy something.
I am trying hard to reduce my debt first. I figure that once I do this, I can make investments which will hopefully act as retirement income for me.
It really is so simple. If you pay down debt that you are paying 18% on then that is the equivalent of getting an 18% return on your investment.
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In 2007, I hope to save or invest 60% of my gross income. I’ve listed these goals in the order of their importance to me. I have already directed my employer to withhold 1,000 dollars per month for my retirement, so my retirement goal is a done deal. This great plan to retirement persons.
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rose786
Well, I think that if you're in serious debt, you should get in touch with a company which provides expert debt advice on various solutions to become debt free, and which doesn't take any money for it, like a not for profit organization.
<a href="http://www.debtadvicetrust.org/debt/debt-advice.html” target=”_blank”>http://www.debtadvicetrust.org/debt/debt-advice.h…
Paying off debt should go first, because you need a good credit record, would you need any emergency credit in the future,
Emergency fund should go second. It could spare, maybe repeatedly, the need for emergency credit. Of course the emergency fund is the buffer space where money goes before making a debt payment.
Investment should go third. A very small money investment need to be exceptionally good to get before paying debt and to get in emergency funds. The smaller the amount, the more high paying and secure it has to be. For this reason alone it is not likely to happen.
Larger investments do not have to be so good to be worthwhile.
It’s wiser to put the money in the emergency fund before it goes to pay off debt.