Friday, January 15, 2021

Savings vs. Debt Repayment: What Comes First?

It is very difficult for an individual to have a single financial priority. Wall Street investment bankers will tell you that their sole financial priority in life is to make more money for their clients so that they can earn greater commissions, but this is an oversimplification of their lives because they likely have obligations such as mortgages, car loans, credit cards, and even putting away money for retirement. Most of us are engaged in a perpetual cycle of juggling financial obligations; we all have bills to pay and people to care for, but from time to time, we may find ourselves with some cash leftover at the end of the month. When this happens, the question is whether we should use that extra money to reduce our debt burden or to save up for retirement.

How Do Compound Interest Investors Approach Savings vs. Debt Repayment

For many compound interest investors, the situation above has only one possible solution, and that is to deposit all extra cash to their portfolio accounts. It does not matter if your retirement date is still decades away; through the magic of compounding, a few hundred dollars today could turn into thousands over the long term. Compound interest fans know that the earlier they start, and the more they contribute, the better off they will be later in life. This should settle the debate of whether you should focus on retirement more than on debt repayment, but there is an exception, and it is related to high-interest debt accounts.

Expensive debts will outpace the rates you are earning

When you have credit cards with very high annual percentage rates of interest, they actually get in the way of your retirement planning. When the debts you carry are expensive, you really do not want to prolong them because, at some point, they will outpace the rates you are earning on your compound interest portfolio, and this is a highly undesirable burden. In this situation, you will want to identify the debt accounts with the highest interest rates and concentrate on paying them before the rest, particularly when you run into money you were not expecting. This is mostly a matter of strategy, and it can guide you towards achieving a more harmonious financial balance.

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