Why You Should Still Save When in Debt

The shackles of debt seem to be a bonding force for many millennials around the country, but it isn’t just Gen Y that is attempting to pay off lenders. Debt is a national problem spanning all generations. To many, it may feel nonsensical to save money while in debt, but it’s an important part of everyone’s financial health strategy.

You Still Need an Emergency Fund

Debt doesn’t preclude anyone from experiencing emergencies. Murphy’s law would suggest those already in the hole should expect more pain to pile on.

In fact, $1,000 surprises happen so regularly that Shannon McLay, a financial planner and author of “Train Your Way to Financial Fitness,” doesn’t even think people should consider them a surprise. The only twist is the type of emergency the money goes toward – perhaps your car, health care or education.
Personal finance experts differ on how much those in debt should have saved in an emergency fund, but they almost unanimously agree some disposable cash is a necessity.

saving jars“Whether or not you have debt, I believe that everyone should have six to eight months of monthly expenses saved in an account,” McLay says. “If your monthly expenses are $2,000, you should have a minimum of $12,000 saved up.”

Matt Becker, a financial planner and founder of the fee-only financial practice Mom and Dad Money, suggests $1,000 as a starting point for an emergency fund.

“That should allow you to handle most of the common unexpected expenses life might throw your way,” he explains.

Hopefully, the unexpected expenses just don’t come back-to-back.

Be Practical About How You Save for Retirement

Employer-sponsored retirement vehicles – like a 401(k) – are often viewed as a good way to save for retirement and earn some money, but only if they come with a match.

“If your employer is matching your contributions, that’s a guaranteed 100 percent or 50 percent immediate return that you won’t get anywhere else,” Becker says. “But if your employer doesn’t match your contributions, then it may make sense to pay off your high-interest debts before investing.”

Paying off a credit card with an 18 percent interest rate will likely give a higher return than investing in the stock market, Becker says. Plus, the return of paying off the card is guaranteed. But he advises those with interest in the 5 to 10 percent range to consider dabbling in investing while paying down debt.

Most personal finance experts are horrified by the thought of bucking an employer-sponsored retirement plan. Yet McLay points to times when it makes sense.

“Everyone needs to assess his or her potential cash needs for the next five to 10 years,” she points out. “If you have high cash goals like buying a home or having children, it may make sense to keep more money in your taxable savings account versus your tax protected account or your 401(k).”

McLay explains it’s important to remember taking a loan out from a 401(k) before the age of 59 ½ will result in a penalty fee of 10 percent of the amount withdrawn and render the initial tax protection of investing the money worthless.

OK, But How Do You Save While in Debt? 

“First, make sure you always pay the minimum on your debts no matter what,” Becker advises. “Making those on-time payments month after month will keep your credit report in good shape.”

One simple way to simultaneously save and pay down debt is to make it automatic. Set debt payments at the beginning of the month, and automate a portion of your paycheck to go toward savings. Then the remaining money in your bank account can be for monthly spending.

Occasionally, a small windfall could speed up the debt repayment timeline.

“Any time you receive extra money, like a gift or a bonus at work, put it towards either a savings goal or one of your debts,” Becker says. “You weren’t counting on spending it anyways, so you might as well use it to do some long-term good.”

McLay also points to the psychological benefit that comes with saving while in debt.

“I advise clients to make sure that they pay down debt as well as build up emergency funds, and then focus on retirement,” she explains. “I have found that when their assets grow, they not only have greater financial flexibility, but they also feel less stress knowing that they have the funds to weather a financial emergency.”

Don’t Forget to Celebrate the Little Wins 

Long-term goals, like being debt-free, are important, but you shouldn’t be so focused on the future that you forget to live in the present.

“Set long-term goals for yourself, but also set smaller short-term goals that you can celebrate along the way,” Becker suggests. “Measure yourself only against your own personal benchmarks, and take pride in the progress you’re making – even when the final destination feels far off.”