No one likes the idea of debt. When someone gets a financial windfall, “paying off debt” is often the answer to the question: “What are you going to do with all that money?” But absent winning the lottery, paying off your debt, at the expense of saving, might not be your best financial strategy.
Your debt is not your only financial obligation: Setting aside savings for both short-term financial shocks and long-term financial goals and retirement should also be on your radar. Unfortunately, many Americans may focus on paying down debt and never get to the savings part.
“The most important thing when managing finances is the need to strike a balance between savings and debt,” said Martha Slaight of Commonwealth Financial Group in Boston. “Everyone needs a plan that lets them both afford their lifestyle today and save for future, all while paying off their debts in a timely manner.”
To maintain the right balance between two competing priorities, consider creating a debt management plan instead of a debt reduction plan. To create an effective and functional debt management plan, it’s critical that you take all your finances into account.
Pay off debt or save?
A debt management plan should include:
- A ranked inventory of all your existing debt, due dates, interest rates, and minimum payments. High-interest consumer debt tends to be the area most people want to pay off first. (Learn more: Debt goals)
- An inventory of all your savings accounts and a list of vehicles that offer a greater return for your dollars. (Learn more: Savings goals)
- A categorized and prioritized budget, so you can see what expenses you can cut to pay off debt and add to savings. (Learn more: Budget basics)
Accumulating savings while you pay down your debt can help you better absorb a financial shock, manage daily living expenses and stay on track to meet your long-term financial goals.
By focusing on accumulating savings, you create a larger financial foundation on which to grow in the future. And, thanks to compound interest, your savings may outgrow the amount you owe.
Think of it this way: You can choose to be debt free within a certain period, and at the end potentially have no savings. Or you can take a little longer to pay off that debt. Yes, you’ll pay more in interest, but in the end, you just might have a good financial cushion to build upon when you are done. If you focus only on your debt, and not your savings, you may miss out on years of financial gain.
So which strategy is best for you?
For many, balance might be the answer. A debt management plan helps you control your debt while still being able to save for the future and accumulate your retirement nest egg.
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This article was originally published in December 2018. It has been updated.