Episode #39: Should I Save, Invest, or Pay Off Debt?
If the first word that comes to mind when you think about managing your finances is ‘overwhelm’ then I’ve created this episode specifically for you. If you know that you need to start to get on top of your financial situation, if you know that you need to save money, if you know that you have debt to pay off, and if you know that you should start investing but the thing that’s keeping you from doing any of this is that you have no idea where to start, then this episode is most definitely for you. So, stick around and I’m going to walk you through a framework to follow that will guide you through the process of saving your money, paying down your debt, and getting started with investing for your future.
There is a tonne of financial information and advice kicking around out there. Some of it’s good, some of it’s not so good, but all of it revolves around some version of telling you that ‘you should do this’ and you ‘need to do that’, and ‘if you’re not doing this thing right then, uh ohhhh you’re in trouble’, and it is very normal if you feel overwhelmed and stuck when it comes to sifting through all the information applying it to your life, and figuring out where you should even start with step one let alone how you’re going to achieve steps two onward.
And one of the most common places that most people find themselves when they first start grappling with their finances, is wondering whether they should prioritize paying off debt, starting to save some money, and when it’s time to dive into the world of investing that money. So today in today’s episode I’m going to walk you through the framework of when and how you should start saving, paying off debt, and investing, and it basically goes in that order. First you want to get a cushion of money saved, then you want to start paying down some debt, then you want to start a system of continuing to pay off debt and investing at the same time, and I’m going to walk you through each of the steps, why, and give you some more resources if you want to dive even deeper into any one of these steps.
Step #1 is to start by saving a cushion of money for yourself, aka an Emergency Fund.
If you’ve caught any of my previous episodes you’ll probably know that this is one of the number one things I recommend everyone do early on to get control of their finances. It is SO important to create an emergency savings fund to act as your financial safety net for when little things inevitably go wrong.
You want to build an emergency fund for a few different reasons. First and foremost, knowing in the back of your mind that you have that safety net will go a long way to creating a more positive feeling when you think about managing your money. There is nothing like living paycheck to paycheck and knowing that you have no margin for error to really mess with your logic and decision making skills when it comes to managing your money. Having an emergency fund will start to reduce the level of fear and anxiety you have around your financial situation and it will make the entire rest of this process so much easier. The second reason why you want to start with your emergency fund is that it will keep you from getting deeper into debt in case you encounter any little financial speed bumps along the way. Have to miss some shifts at work, that’s okay because you have your emergency fund, if your car needs an unexpected repair with a big price tag that’s okay because you have your emergency fund. It will start to create a buffer of liquid cash between you and the little financial problems that inevitably arise that will get in the way of you taking control of your finances.
When it comes to building your emergency fund, the amount of money that you have saved in there depends on your own financial situation and there are multiple schools of thought around how to do this. The most generally prescribed advice these days for people our age is to keep 3-6 months of basic living expenses in your emergency fund. Some other schools of thought say to keep $1,000.00 in your emergency fund. In my opinion, these days $1,000.00 is a pretty cheap emergency, but the idea with this is something is better than nothing and just getting $1,000.00 into that account will help keep you more financially safe and secure. Now you likely won’t be able to funnel all of your money into setting up that emergency fund right away because you have bills to pay and you may also be working on paying off some debt that you can’t miss payments on. Don’t let yourself go into more debt to create your fund, but the idea is to keep paying the bare minimum for your life and outstanding payments without funneling any other cash into those areas until you’ve build up your emergency savings account. Also, to keep your emergency fund secure and far away from the temptation of spending it on anything other than an emergency, you want to set it up in a separate account called a high interest savings account. This serves two purposes, one you won’t be tempted to accidentally spend it like you would if it were just sitting in your regular bank account. Two, these bank accounts offer the highest interest rates on the market while still keeping your money liquid. This means that slowly and over time the account will start to earn you money in interest which will help bit by bit to build it up faster. Any little bit helps when it comes to creating this fund, and it doesn’t cost you anything to set up a high interest savings account to earn a couple of extra dollars every month. If you’re located in Canada like I am, I’ve linked my favourite high interest savings account that’s currently available to Canadians in the description for this video, and I highly recommend you go open up an account.
And finally on this topic if you’re already glossing over because it feels impossible for you to pull together a few extra dollars here and there to build your emergency fund, I want to you to take a look at episode #16 which is all about 10 ideas for ways you can save or earn a bit of extra money so that you can put it all towards your emergency fund.
Step #2 is to pay off any high interest debt you may be carrying.
Once you have your emergency fund built, however much that is for you, you want to start the process of wiping out your high interest debt. This is usually consumer credit card debt, and if you’re carrying any it’s costing you a lot of money every month and you need to plug that hole as soon as possible so you can stop watching your hard earned dollars melt away into the credit card companies pockets, and start putting that money toward your own life and well being instead.
So, first you want to take stock of all the outstanding debt you have, and make sure you write down the interest rate that you’re paying for every single debt item on your list. This will allow you to rank them from most expensive interest rate to least expensive interest rate, and start paying off the most expensive rates first. For example, if you’re carrying credit card debt, chances are you’re paying somewhere in the ballpark of 20% interest on that, which is absolutely huge. A good rule of thumb is any debt with an interest rate of more than 7-10% is high interest debt and you want to pay all of that off as part of step #2.
Once you have your emergency fund built, you’re probably now in the habit of saving more money and diverting it to your emergency fund. All you want to do is divert the money that was going to your emergency fund, and start using it to pay off your highest interest rate payments first. Don’t get tempted to spend the extra cash you’ve found on anything else, I know you’ve been working hard to make that emergency fund and you probably want to have a little fun, which is okay, but stay disciplined and get rid of the high interest debt. It’s going to feel so good when you get that weight off your shoulders, and you’ll be amazed by how much more money is available in your life now that the credit card company is no longer sucking you dry.
Step #3 is to create a system of continuing to pay off your low interest debt, AND start saving and investing money for your future at the same time.
The idea behind this step is that when you’re saving money and investing it in the stock market, if you’ve done your research and are investing safely, buying things like ETF’s, and using a long term buy and hold strategy instead of day trading your head off and yoloing your money away then you can expect to earn an average annual rate of return of between 7-10% over the course of your investing life. IF you only focus on paying off all your debt, specifically your low interest debt like say a mortgage, that’s going to take you many years most likely, and you’ll be missing out on being able to earn 7-10% on the money that you used to pay off that low interest debt.
This is where the term ‘opportunity cost’ comes in. Paying off all your low interest debt before deciding that you’re ready to start saving and investing for your future will have an opportunity cost to it, because you’ve missed out on all the gains and compounding interest of the stock market during those years that you were only paying off low interest debt.
So, what you want to do is look back at your debt list, check all your interest rates again, write them down, and make sure that everything left on that list still only qualifies as low interest debt, and then continue paying that off as usual based on whatever your payments are while at the same time starting to save some of your extra money, put it into a retirement account, and begin safely investing it for long term gains over the upcoming decades of your life.
And the thing is by now if you’ve already become better at saving money because first you tucked it away into your emergency fund, then you aggressively paid off your high interest debt, AND you’re no longer paying massive amounts of interest to other companies, you should be able to find yourself with a surplus of cash available to you that you can start using for saving and investing.
And I really really don’t want you to skip this step. I know it’s going to feel great once you have your emergency fund built, and you’re not carrying any more crazy debt, but it’s important to keep your money habits strong, and not fall into the trap of funneling so much more money into your lifestyle now that you’re feeling safe and debt free. Enjoy the feeling, and there’s nothing wrong with treating yourself, but don’t sacrifice the saving and investing step here because this is what will bring you from no longer being in debt, to actually being able to build and grow your wealth passively so that you can look forward to a comfortable future ahead of you.
To recap, if you’re feeling lost and overwhelmed about where to even start managing your money, try sticking with this three step framework and you’ll be amazed by how far you can come. Step one is to build yourself an emergency fund to protect yourself, step two is to pay off any high interest debt so you’re not bleeding money unnecessarily in absurdly high interest fees, and step number 3 is to then move on to paying off your low interest debt if you have any while simultaneously setting up a system to start saving and investing your money for your future. It will absolutely take time, it will 100% take diligence and patience, but you will be able to get out of where you are right now and how you’re feeling about your money.
Linked Resources
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