“Always save 20% of your income!”
“Pay down high-interest debt as fast as possible!”
“Always have an emergency fund!”
You’ve probably heard some (or all!) of these common personal finance sayings. You know that saving money is important, and paying off debt is important.
But if you’re still asking yourself what am I really supposed to do – should I save money while paying off debt? Should I just pick one? then I’ve got you covered.
Today, I’m going to walk you through why the answer is yes, you should be saving money and paying off debt at the same time.
We’ll also go through how you can decide what and how much to save and how to get started paying off debt.
Let’s get started!
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Although I am a CPA by profession, I am not YOUR CPA. All content and information in this post is for informational and educational purposes only, does not constitute accounting, tax, or financial advice and does not establish any kind of CPA or accountant-client relationship.
Why it’s Important to Save Money
Saving money is important because it can reduce anxiety around money and give you the ability to consider opportunities you otherwise could not.
Plus, you work hard for your money so you should put it to work supporting your future! Have you heard the saying “pay yourself first?” Saving is paying yourself first.
We’ll go into more detail in a minute about the different types of savings goals, but overall, having some money set aside gives you a safety net for the unexpected.
One of the most stressful parts about money for most people is that they never feel like they have enough at the end of the month.
What happens if your car breaks down? What if you get laid off from your job?
Keeping some money saved will give you a lot of peace of mind that you can handle whatever life throws at you without also having to worry about how you’ll pay your rent.
Why Paying off Debt Matters
There are three main reasons I think paying off debt is important.
- Paying interest on debt costs you money.
- Debt payments limit your options.
- Owing money to other people causes stress (even if you don’t think you feel it).
Let’s quickly break each of these bullet points down.
First, you are costing yourself money by holding onto debt (or adding more debt), especially if it has a higher interest rate. I’m currently working on paying off one of my credit cards because the interest alone is costing me $300 a month.
That’s like a car payment in just interest…
So, every time I make a $400 payment, for example, only $100 of that is actually going to pay the balance down. Ugh.
This is why debt limits your options – I can’t use that $400 I’m paying to my credit card for anything else because I have to pay that bill.
I could be saving that money or investing it instead. (Which really costs me even more money – I could be having that $400 making me even more money if I had it invested!)
Debt can also cause anxiety about money, even though you might not realize it’s because of the debt.
If you feel like you never have enough money to spend on the things you really want, is it because all your income is going to regular debt payments?
Paying your debt off will free up money that you can then use for the things you’d rather be spending your money on.
Should I Save Money While Paying Off Debt?
I struggled a lot with sticking to a focused plan with my money management for over a year when I first started budgeting because I would change my goals every time I heard another piece of advice about something I should be doing.
Usually, the shoulds were also coming from people who were giving advice but not saying why they were giving the advice.
So, here’s the reasoning behind the should I’m about to give you.
I do think you should be saving money while paying down debt.
Here’s why: it will end up costing you more money (and stress) in the long run if you don’t have savings to cover emergencies or unexpected situations.
Say your car breaks down, but you’ve sent every penny you have to debt and the only money you have in your bank account is what you need to pay bills this week.
How are you going to pay for the car repairs? Most people would have to pull out a credit card.
If you have been working hard to pay off debt, but you don’t have any money saved for situations like these, you are going to end up going further into debt to bail yourself out.
How to Prioritize Savings vs Debt Payments
Whether you want to focus more on saving or paying down debt is entirely up to you. Just because you are doing both doesn’t mean one of them can’t be more of a priority.
It will totally depend on what will give you the most peace of mind.
If you have never had more than $100 saved and are constantly stressed that your entire life will fall apart if your next direct deposit doesn’t go through, then you most likely want to prioritize saving for a little while.
Or, if you have between $500-1,000 in your checking at any given time, then you probably should just organize your savings going forward and prioritize your debt payoff plan. (If you don’t have a debt payoff plan, don’t worry – we’ll cover that later in this post!)
To make it simple, here’s what I would recommend:
- Save an emergency fund
- Set up automatic sinking funds
- Then, prioritize paying off your debt
We’re going to dive deep into each of those steps, so let’s keep moving right along!
Simple Strategies for Saving Money
I personally think it’s better to have actual goals for the money you are saving instead of just saving 20% of your income or saving whatever is left at the end of the pay period.
This helps you stay motivated to continue saving and keeps you from feeling like you are saving money that could be used for other things (like debt payoff).
I mentioned saving an emergency fund and setting up sinking funds – those are the two goals I think you should focus on while paying off debt.
Set Up An Emergency Fund
Saving an emergency fund is probably the best money move you could make this year.
Remember when I said saving money will reduce your money anxiety?
The whole point of an emergency fund is to give you a buffer for when the unexpected happens in life. And the unexpected is always going to happen at some point.
Let’s say your car needs unexpected maintenance, or your dryer tries to catch on fire, or your guinea pig suddenly needs emergency surgery (… all things that have happened to me).
Instead of panicking when you get the bill, everything will be smooth sailing because you know you have the money in the bank waiting for times like these.
How Much Should I Save In My Emergency Fund?
This is going to depend on your situation and your comfort level with risk.
In general, I’d say start off with between $1,000-$2,000.
This will be enough to cover most emergencies that could come up without wiping the entire fund out.
It’s also not so much money that it will take you forever to get it saved. Focus for the next 3-6 months and you could have your emergency fund ready to go.
I personally like to hold onto around $1,500 because that gives me the most peace of mind without making me feel like I’m holding onto a bunch of extra money I could be putting toward debt payments.
Once you have paid off your debt, you should focus on increasing your emergency fund to hold six months’ worth of expenses.
Set Up Sinking Funds
If you’ve never heard of sinking funds before, they’re super simple.
Basically, you set up savings accounts for specific things you know are going to happen at some point in the future that you add to over time.
Because you know they are coming, they are not really emergencies. Christmas is not an emergency because you know it’s going to happen at the same time every year.
For example, let’s say you look back at the last few years and you normally spend about $500 on Christmas gifts for your friends and family.
Take that $500 and divide it by how many months there are between now and Christmas. So if it was January, I’d divide that $500 by 12.
Instead of coming up with $500 for gifts in December (or swiping your credit card!), you would put $42 in your Christmas sinking fund each month. Make sense?
If not, head on over to this post that goes over sinking funds and why you need them.
To give you some ideas, the sinking fund categories I usually use are vet fund, car maintenance, Christmas, property tax (for my car), travel, and gifts/miscellaneous.
Automate your savings
This is my #1 tip when it comes to saving money!
Set up your bank accounts to auto-transfer a set amount into your savings account every time you get paid. I actually had a second direct deposit account set up with my employer.
If you don’t even see the money hit your checking account, you can’t be tempted to use it for anything other than savings.
If you want to go one step further, set up your savings account at an entirely different bank so you can’t easily transfer it back to your checking account.
I recently set up direct deposit to a separate bank for my sinking funds and it’s been a game changer.
Automating your savings removes all temptation to use the money for something else instead of putting it into your savings.
Invest in Your 401K
This is a kind of investing rather than saving, but I think it’s an important thing to cover.
You always want to be contributing to your 401k plan (unless you literally can’t cover your bills), especially if your employer offers a match.
I’m not going to go deep in this post explaining how compound interest works but just know this – any amount of time you aren’t putting money into your retirement account, you are costing yourself money that you won’t be able to make up in the future.
The longer you are putting money into your retirement account, the more you will have when it comes time to retire later.
Don’t get stuck trying to figure out what you should be contributing if you’ve never invested in a 401k before. Keep it simple… if your employer offers a 3% match on your 401k, then set up a 3% contribution to start.
Once you get through a few paychecks, you won’t even notice the money is gone. And if you’re already contributing more than that, cool, just leave your contribution alone!
You can go back and evaluate your retirement investing later once you’re confident you have your budget, savings, and debt payoff plan figured out.
I think you’ll like these other posts about saving money:
- 7 Tips on How to Save Money and Reduce Spending
- 7 Ways to Save Money on Groceries
- Get Your Finances On Track With a Printable Budget Binder
How to Get Started Paying Off Debt
Once you’ve established how you’re going to focus your saving, you should also make a plan for how you’re going to pay off your debt.
Making random debt payments (or only making minimum payments) and expecting to get your debt paid off isn’t going to work.
Stay motivated and get your debt paid off faster by having a strategy.
You can choose between two main methods that are commonly used for debt payoff: the debt snowball method and the debt avalanche method.
Pay Off Debt Using the Debt Snowball Method
With the debt snowball method, you pay your debts off in order from the smallest balance to the largest.
This method focuses more on behavior. It takes less time to pay off smaller debts, so you will build momentum as you move from debt to debt.
Here’s how it works:
- Make a list of all your debts and their balances and put them in order from smallest to largest.
- Write out the minimum payments for each debt.
- Pay the minimum balance on all of your debts except for the one with the smallest balance.
- Pay the minimum balance, plus any extra money you can on the smallest debt until it’s paid off.
- Once the smallest debt is paid off, take the minimum payment amount and any extra money you can and start paying it on the next debt on the list.
As you move through the list of your loans, you’ll have more and more money available to pay on them as you wipe out the minimum monthly payments from the smaller loans.
It becomes a snowball because the payments get larger the further you get!
Pay Your Debt using the Debt Avalanche Method
The debt avalanche method is more focused on math than behavior.
The avalanche method has you pay off your debts according to their interest rates. It’s great for people that have the majority of their debt in high-interest credit cards (like me).
This method focuses on paying the least amount of money in the long run.
Here’s how it works:
- Make a list of all your debts, their balances, and their interest rates.
- Put them in order from the highest interest rate to the lowest.
- Write out the minimum payments for each debt.
- Pay the minimum balance on all your debts except for the one with the highest interest rate.
- Pay the minimum balance and any extra money you have available on the highest interest rate debt until it’s paid off.
- Once the first debt is paid off, take the minimum payment and all the extra money you can and start paying on the interest rate with the second highest interest rate.
Over the time you are paying off debt, you will end up saving yourself money on the interest that you’re paying. As you continue to make minimum payments on all of your loans, the principal balance will go down.
With the avalanche method, by the time you get to the loans with the lower interest rates the minimum payments will likely have decreased.
There’s an avalanche because not only are you paying more in extra payments with each paid-off loan, but you are also lowering minimum payments.
I highly recommend checking out this post that compares the debt snowball method to the debt avalanche method if you want to know more before creating your debt payoff plan.
Conclusion
You made it all the way to the end!
Now that you know that it’s actually going to save you money in the long run if you save and pay off debt at the same time, it’s time to take a hard look at your budget!
Make sure the financial goals you have for yourself are setting you up for success and make tweaks where necessary.
Then, make a plan and stick with it.
Let me know if you have any questions in the comments below!
Here are some other articles I think you’ll really enjoy:
- Should You Use the Debt Snowball or Debt Avalance Method?
- How to Stay Motivated While Paying Off Debt
- Why You NEED an Emergency Fund
- How She Paid Off Over $16,000 of Debt in One Year
