Should I Save Money, or Pay Off Debt?

Should I Save Money, or Pay Off Debt?

August 24, 2020

Tagged As: Wealth Management

When you’re getting your financial footing after taking out student loans or recovering from credit card debt, it can be hard to figure out whether you should focus on repaying that debt or saving what you can for a rainy day. There’s also the dilemma of whether to set money aside in a savings account or make a larger contribution to a 401(k) plan, if you have a full-time job.

If you feel overwhelmed in trying to navigate this conundrum, you’re not alone. Here are some questions to ask yourself to help determine the right financial path for you.

 

What’s your interest rate?

You should know the interest rate on your debt, which is almost always expressed as an annual percentage rate (APR). This is the amount that is charged to its balance over the course of a year. The higher the APR, the more you’ll have to pay in interest as long as the debt remains unpaid. Credit cards tend to have a higher APR than student loans and some other kinds of debt.

Paying off debt, especially higher interest debt, is a good idea. However, it’s important not to overlook the importance of saving for your future.

 

Do you have a 401(k)?

You can grow your money over time – including money contributed on your behalf by your employer – by taking full advantage of your employer’s 401(k) plan. Most employers who offer 401(k) plans also provide a matching contribution. For example, if you contribute a certain percentage of your wages, say 6 %, the employer agrees to match up to 50 % of your contributions. Think of that match as a return on your investment – in this example, a return of over 50%!

Annual Salary = $50,000 You contribute 6 % = $3,000

Employer matches 50 % = $1,500

If you are participating, make sure you are taking full advantage of any employer matching contributions. If you don’t know what your employer offers, check with your human resources department to determine what retirement savings benefits might be available to you.

If you’re not participating already, you should!   Over time, a 401(k) can grow to become much more valuable than what you and your employer contribute, thanks to the power of compounding returns. Compounding transforms your working money into a state-of-the-art, highly powered income-generating tool. When your investments generate earnings, those earnings are added to your account and reinvested. Now you have a larger pool of invested money – your contributions plus your earnings – and the opportunity to generate even more earnings on those invested funds.

compounding graphic

Assumes 8% growth rate compounded annually at the end of the year.  Actual returns and growth are subject to market fluctuations and future investment performance is not guaranteed.

By increasing the amount you are contributing, you increase the potential benefit you may realize from compounding. The longer your money is invested, the more you benefit from the power of compounding. 

 

Do you have an emergency fund?

Financial experts recommend having up to six months of living expenses set aside in a safe, low risk investment such as a savings account. While it may seem overwhelming to think about setting aside that money all at once, especially if you are already in debt, we aim to make it easier to save with Goals.

Goals is a new feature in Hills Bank Online. It allows you to create savings targets and start setting aside money with automatic, regular transfers that are calculated to your timeline. By automating the process and choosing as little of a payment as you want, you can take the pain out of creating an emergency fund. You’ll see a visual reminder of your saving every time you log into your account.

 

Saving, investing in a 401(k), or paying off debt?

All of the options above can be smart financial moves depending on your situation. But how do you decide what’s right for you?

First things first: you should make sure you can handle your financial needs in the short term. Having cash on hand or easily accessible can protect you against sudden, unexpected expenses and the need to take out additional loans.

After that, the key comes down to understanding compound interest and how it can work for you – or against you.

If you have debt with a high APR (say, higher than 8 or 9%), you want to prioritize paying that off before focusing on saving or investing in a 401(k). That’s because the expected return you might get from putting money into your 401(k) is lower than the amount of interest you’ll need to pay on that debt in the long term. And by paying down your loan early, you could save big. For example, if you paid $50 extra every month on a 15 year $20,000 student loan with an 8 % interest rate, it could be paid off in 10 years – five years ahead of schedule! That’s five years of interest charges that you won’t have to pay.

If paying extra on debt isn’t an option for you, look into any opportunities to reduce the interest rate on your loans: you may be able to refinance at a lower rate. Some companies also offer interest rate discounts for “going paperless” and signing up for automatic payments. Every little bit helps.

Life is about choices and finding a balance. Don’t make paying off debt, saving for your future, and having some cash on-hand an either-or strategy. Take advantage of programs available to you to maximize your savings and minimize your debt. Make a plan to allocate to all of these financial strategies in a way that works for you.

For any personal finance question you have, we invite you to reach out to a personal banker through the HERE by Hills Bank app. And if you’re looking for additional guidance in 401(k) accounts, financial planning, or investments, our Wealth Management Group is here to help. You can schedule a virtual meeting with one of our experienced Trust and Wealth Management Officers by calling 1-800-899-8858. We look forward to serving you as your trusted advisor.

Investment products are not a deposit, not FDIC insured, not insured by any government agency, carry no bank guarantee, and may go down in value.