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When you have debts to pay, saving money in savings account can seem counterintuitive. After all, quickly paying down debt is good. But what about an emergency fund? What about ensuring you have enough to cover your bills if you become unemployed? When someone we’ll call Jack posted a similar question online, just about everyone had advice on which option was better. Is Beefing Up Your Savings Account a Smart Move?
1. Eight Percent
Someone suggested Jack should first pay down anything with an interest rate over 8%. According to the netizen, investments usually run at 7-9%, and you can pay down a car or mortgage loan while saving money for retirement, emergency funds, etc.
2. Pay Down Debt
This choice was popular for many commenters to Jack’s question. His debt was manageable — about $4K — so it’s understandable. But if he’s using credit cards as a backup emergency fund, is that the best way to go, especially considering interest rates?
3. Emergency Fund
One person suggested that Jack put back enough for a decent six-month emergency fund and start paying off his debt. This amount would allow him to continue to pay his bills should something happen that made it impossible for him to work, and he’d have room to work with his creditors while he finds different employment or whatever he needs to do.
4. Cash Is King
While this isn’t as true now as during my childhood, cash still talks to people looking to make money quickly. My husband walked into a car dealership with $7,500 and walked out with a $10K vehicle, tax, tag, and title included. Although cash will work in the right circumstances, an emergency fund is essential.
5. Heavy Handed
When we think about debt, we often want to clear it as fast as possible, especially if we know it isn’t long-term debt like a car loan. However, that isn’t always the best approach, especially if you don’t have any funds set back for those inevitable emergencies life throws your way. Paying all your debt and having no savings can hurt you.
6. High-Interest
If you have a lot of high-interest debt, creating an emergency fund and ignoring the debt might not be the best approach, either. If you’ve got thousands of dollars in debt growing at 30% every month, you’ll owe astronomical amounts by the time you build up a solid six-month emergency stash. Sometimes, adding a little to your store while staying on top of your debt payment is better than skipping the debt altogether.
7. The No-Money Approach
Michael Dinich, a former certified financial planner and owner of Wealth of Geeks, believes an emergency fund is necessary before paying down debt. What if you don’t have any money set aside for unexpected circumstances like the loss of a job, major car repairs, or unforeseen medical bills? In that case, you’re asking to accrue considerably more debt than if you have cash to fall back on. If you have nothing set aside, start building your emergency fund as fast as possible, then tackle that debt mountain one chunk at a time.
8. Where to Store Savings
Figuring out where to put your emergency money is one question that CFPs get a lot. Do you place it in your 401(k) or a high-yield savings account? Should you keep the cash at home? A few good options are a savings account, even if it’s low-yield. Either way, you can withdraw that money should an unexpected expense arise. Also, if you have equity in your home, you can open a line of credit without increasing your monthly mortgage payment, should you need considerable access to money.
9. Costs to Consider
Many people avoid saving for emergencies because they need to know how much to save or what to consider. You should consider all household bills like mortgage payments, electrical costs, groceries, car payments, gas (propane and gasoline if needed), and other payments (outside of debt). Once you have that rounded figure, multiply it by the months you want to save for. If your bills total $3K and you want to save six months’ worth of bills, you’d need $18K in your emergency fund to have a nice cushion.
10. Variable Income
For entrepreneurs, solopreneurs, and the self-employed, funding an emergency stash when your income can vary wildly month-to-month is challenging to get a figure on. Still, covering your basic needs is essential. Get those regular house bills totaled and extend your savings out nine months to a year just in case you have some leaner months, which we all know happens when you work for yourself.
11. Too Much in Savings
If you are sitting on considerable savings, as in more than you need for a healthy emergency fund, consider withdrawing your portion over that emergency stash and paying down your debt. Sitting on more money than you need while interest accumulates on your debt is the last thing you want to do.
In the End
No matter where you stand with your debt and savings, it’s clear that having an emergency fund is a must. Being able to cover your monthly expenses should the unthinkable happen is excellent financial sense. So is paying down debt if you already have a good emergency money cushion. The best scenario is using extra savings you don’t need for any surprise expenses to pay that interest-yielding debt.
Source: Reddit, Forbes, Wealth of Geeks.
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