No, you don’t need to pay off all of your debt before saving
There’s an extremely popular piece of financial advice that I couldn’t disagree with more, and it’s about time we talk about it. The advice is that you basically shouldn’t do anything like saving or investing until you pay off all of your debt. I don’t fully disagree with this advice, because it’s sometimes true. The problem is that people use this as a blanket statement without taking into account any nuance at all.
The reality is that you need to start investing in your financial future sooner rather than later and having some debt while doing this can be a completely rational and even a smart decision. So today, we’re going to break down the nuances.
Why they tell you to pay off your debt first
The inspiration for this post came from a TikTok that came across my page last night. A podcast host asks Sallie Krawcheck from Ellevest Columbia Business School what the worst finfluencer (financial influencer) advice is.
“Saying that people needed to build up their savings before they were paying off their credit card debt. Financially, that’s a huge mistake. Whatever the savings you have, pay off the credit card debt. Even if that means you’re zeroed out. Because the credit card debt costs you so much and the savings account isn’t earning you anything. So you’re just transferring value. I thought that was just numerically incorrect advice.”
Listen, I’m not saying I’m smarter than someone whose career is in finance, but there are two things you need to understand:
Similar to science, there’s debates on certain topics (like this one)
Some advice comes from a privileged position
I primarily made this Substack for people like me who grew up with nothing and/or have been broke most of their lives. When I hear this advice, and it completely lacks nuance, I’m like, “You probably came from a family that taught you the importance of saving and investing at an extremely young age.”
I’m 38 and only started fixing my finances within the last 5 years or so. Unless I start making a lot of extra money, there’s no way I’m going to have enough saved up by the time I hit retirement age. This is one reason I think it’s silly to tell all of us we need to completely eliminate debt before we start saving and investing.
I’ll explain this more shortly, but first I need to discuss how her advice comes from a good place and may be smart for some people.
First off, she says, “The savings account isn’t earning you anything.” That’s incorrect, and I’m not even sure why those words came out of her mouth. I just spoke about high yield savings accounts in a recent post. I explained how you need to make your money work for you, and you do this by putting it in a high yield savings account, which can earn you 4% to 5% interest.
Even regular savings accounts earn you money but at a much lower rate. So, why did she say a savings account isn’t earning you anything?
A more accurate statement is that your savings account is earning you less interest than most credit cards are charging you. Currently, the average APR for credit cards is 24.66%. So yes, 24.66% is a lot more than any savings account will earn you.
What she’s saying is that if you’re racking up credit card interest, it’s not smart to save and invest before paying off your debt. In that same post, I discuss compound interest, and yes, if your credit card debt gets out of control, it’s insanely hard to pay it off.
So when should you use this advice? When you’re swimming in high-interest debt. That’s when. But now, let’s take into consideration the nuances that these people often completely neglect.
Some debt is totally fine
I was first introduced to the idea that some debt is totally fine when reading Nick Maggiulli’s awesome book Just Keep Buying. I actually interviewed Nick on my old podcast, and we discussed his book as well as this specific topic.
Nick is a big nerd (in a good way) about numbers when it comes to personal finance. His book dispels a bunch of myths, and one of them is this one about how eliminating debt is the right strategy for everyone.
I’ll use my situation as a primary example:
The primary credit card that I use is the Capital One SavorOne credit card. It’s one of the best credit cards out there. One of the best perks about this card is that there’s 0% interest for the first 15 months.
I got this credit card last June, which means I don’t pay any interest until August. So why on Earth would Susie’s advice apply to my situation? The whole idea behind it is that your savings and investing won’t earn you as much as the interest you’re paying on your credit cards. But if I have no interest fees, then that’s clearly not applicable to my situation.
Not only is there no interest, but this is a cash back credit card. I earn between 1% to 5% cash back whenever I use this credit card, and that’s free money. I primarily use this card for dining, entertainment, and groceries, which means every time I spend money at any of those places, I’m basically getting 3% off while also not accruing interest.
What you need to realize is credit cards aren’t doing this out of the kindness of their hearts. They’re hoping you don’t pay your bills and that you will rack up interest and late fees. Well, I use credit cards like a debit card and often don’t spend beyond my means.
For example, my girlfriend and I have a grocery budget. I get all of our groceries with this credit card, and then I pay that amount off with my credit card most of the time. And if I don’t, I just need to be mindful of paying it down before I start having interest charges…in August.
The next caveat is that the interest charges are also in direct relation to how much credit card debt you have.
Although I’m not paying interest on this card, some of my other cards are charging me interest. Let me take a second to tell you how much some of those interest charges are:
2nd Capital One card April: $0.52
2nd Capital One card March: $7.37
Apple card March: $1.73
Amazon card September: $6.62
After looking this up, I realized I’m paying even less interest than I thought. I regularly have a balance on my Amazon card, but I haven’t had an interest charge since September.
Anyway, back to my point. Each month, I’m putting $200 in my savings account, $200 into my Roth IRA, and 6% of my pre-tax income into my 401(k). According to CreditKarma based on the last time it checked, I had a total of $3,314 worth of credit card debt, which is only 6% credit utilization.
So, these people are telling me that I should be forgoing all of my automatic investments and savings of hundreds of dollars each month because I’m paying less than $20 of interest per month?
Come on, now.
This credit card debt is for a multitude of reasons, and one of those reasons is the week-long vacation my girlfriend and I just went on. That was the best trip of my life, and we saved up for most of it and put the rest on a credit card. I should have passed that up just to avoid having any debt?
If I get charged a little bit to borrow money for an amazing experience or something that brings me joy, so be it. Personally, I think that’s not a bad idea for most people.
The key is to be responsible about your debt.
How to manage your debt responsibly
If your debt is out of control, I wrote about what to do in this post. I don’t want you reading this and think, “Chris said I can rack up all the credit card debt I want, and it’s fine!” No, that’s not what I’m saying. What I’m saying is to do the math and be responsible with your debt.
I believe a major part of fixing our financial lives is to enjoy some of our money. If fixing our finances just means paying bills and being miserable, it’s not enough to motivate us. We need to be able to treat ourselves, and if that means having a little debt and some small interest charges, so be it.
So, how do you manage your debt responsibly? Here are some tips:
Find low or no interest credit cards: As discussed, my main credit card has no interest until August. Before that, I used a different SavorOne card that had no interest for 15 months. Once this one runs out, I may find another new one. Remember, you get the lowest interest rates when you have a good credit score, so get your credit score right.
Find cash back credit cards: Cash back credit cards are free money when used responsibly. When you get cash back, you can have them send you a check or you can apply it to your balance, and I do the latter. Every now and then, when making credit card payments, I redeem the cash back rewards to pay down the credit card bill.
Pay more than your minimum: Some debt is fine, but I actually pay a lot more than my credit card minimum each month. The minimum payment is like $25 to $35 on most of my cards, but I’m paying thousands on these cards each month because I use them like debit cards. What helps me ensure my balance doesn’t get too high is caring about my credit score. You want your credit utilization under 30%, and i try to keep mine under 15%. Once it starts getting higher than that, I calm down on my spending and pay even more back toward my debt.
Do the math: If you start seeing your interest fees are getting high, you need to start paying down some debt until they’re as low as possible. Have a number in your mind that you’re OK with paying. For me, if any individual card is charging me more than $10 in interest per month, that’s a problem, and I’m going to start paying that card down as much as possible.
If you’re asking, “How do I find those credit cards with low interest and good cash back?”. Do what I do, simply Google “best cash back credit cards” and “best low interest credit cards”.
To reiterate, many of us are getting a late start in life when it comes to fixing our finances and planning our financial future. If I didn’t sell you on the idea that having a little debt is OK and that you should start saving and investing, then use a retirement calculator like this one.
According to the Wall Street Journal, you need about $1.3 million to fund a 30-year retirement.
It’s also important to note that everyone has different opinions on the amount. CNBC says you should have about $835,453 for a 25-year retirement and $1 million for 30 years
Either way, that’s a lot of money, which is why you need to start sooner rather than later. According to the retirement calculator, I’m nowhere close to what I’ll need to retire. This is assuming that I need $3,210 to live off and that I’ll live to my 90s:
So yeah, if you need motivation to start saving and investing ASAP, take a glance at a retirement calculator every now and then. I look at this and think, “I need to figure out ways to make more money and start funding my retirement more.”
I don’t know about you, but I don’t want to be one of those 80-year-old people working at Walmart. I’m a workaholic and don’t imagine myself ever fully retiring, but I want work to be a choice and not a necessity when I’m older.
Hopefully, I did this topic some justice, but I highly recommend you read Nick’s book. He explains all of this much better than I do, and he’s not the only person who thinks having some debt is fine. Just be smart about it.
When it comes to our personal finances, we have to juggle a few things and really think it all through. Figure out what works for you, and make it happen.
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