This is a common question posed to financial planners and advisers: “Should I save more for retirement or pay off debt first?” Even well-known personal finance pundits disagree on this one.
Mathematically, this is a fairly simple question to answer. Behaviorally, however -- actually taking action and sticking with the plan – approaching this question can be much more difficult.
Let’s assume you sat down recently and reviewed your monthly budget.
During that exercise, you were happy to discover that you have a couple hundred “extra” dollars available each month.
You now face the happy dilemma of deciding what to do with those dollars.
Your basic options are simple, of course. You could spend it, you could save it, or you could pay off some debt.
What the Experts Say
As I mentioned, even seasoned financial pros disagree as to the exact approach to take when deciding between paying off debt or contributing more to retirement savings.
What we all agree on, however, is the importance of having and staying with a definite plan to pay off expensive consumer debt in a timely fashion.
For example, personal finance radio personality Dave Ramsey recommends not even bothering with retirement savings at all until you first pay off all consumer and student loan debt.
Once you become debt-free, he then suggests redirecting 15% or more of your income toward retirement savings. Almost every other personal finance expert recommends more of a balanced approach, such as:
Contributing to your employer’s retirement plan at least up to the percentage they will match.
Regularly setting aside cash into an emergency fund every pay period.
Paying off consumer and student loans, either in descending order according to interest rate or ascending order according to balance.
We could spend hours standing around the water cooler debating the pros and cons of each approach.
The important part is to pick a strategy – any strategy – and then stick with it. Briefly, though, let’s consider the upside and downside to these strategies, including some practical armchair psychology that might help you determine which method best fits your personal preferences.
The Mathematical Approach
If the purity and logic of a straight mathematical approach appeals to you, then the solution to the debt vs. savings dilemma is probably fairly clear.
Do both. Contribute at least up to the maximum matched percentage in your employer’s retirement plan.
This will capture an instant and guaranteed return on your investment, and you won’t feel as if you are missing out on a benefit by not participating.
With respect to your debt payments, the strategy is also quite straightforward.
Pay the minimum required monthly amount on all debts to keep them current, of course. All available additional dollars from your budget goes to the highest interest rate debt until it is fully paid.
We call this the DebtBlaster approach, and it is by far the quickest way to eliminate your debt.