Q&A: Which should I prioritize, saving or paying down debt?

January 22, 2021

Allworth Co-CEO Scott Hanson answers a reader’s question about how to juggle paying down debt while also saving for the future.

Q: “I swear I make good money, but I’ve finally come to terms with the fact that I spend too much. (I have debt and pretty much zero in savings!) Should I focus more on paying down that debt or on building up my savings?”

-Lydia Q

Great (and timely) question!

As much as any time that I can remember, I’m being asked whether it’s better to focus more on paying down debt or saving.

Since you apparently have a good job, this is what I would recommend you do (with the caveat being there is no "one size fits all" remedy and I have limited details on your situation).

When should you prioritize saving above paying down debt?

The short answer is: Right now, when you don’t have any money saved.

Let’s start from scratch. You’re in debt, but you can still make all your minimum monthly debt payments, you have little or no savings, and, as you’ve said, you spend too much, so you have at least some income left over each month to either apply to debt or to save.

And maybe, with a budget, you’ll even have a lot left over.

First, zero money in reserve for emergencies is a disaster waiting to happen.

I understand that you might be thinking that first you’ll pay off the debt, because you can always get advances and reborrow from your credit cards in an emergency. But my experience has been that’s a terrible idea because it invariably keeps you in the debt cycle.

I suggest you first address one issue, and then the other.

If you don’t have at least three-to-six months’ worth of money in cash (AKA, emergency savings), you should rein in your spending and focus on accumulating that first. (You can even have money automatically deducted from your paycheck and then deposited directly into your savings account.)

The goal is to just get something headed in that direction each month. (Speak to a fiduciary advisor who can help you get a plan in place.)

I’m not saying it’s going to be easy. There are obviously lots of moving parts. And your fledgling emergency savings balance may well likely take three steps forward and one step back. But, the fact remains, that while this may not be true for everyone, your priority should almost certainly be to get an emergency fund established before you pay down debt.

Free money and retirement accounts.

And before we move the discussion to your debt, there’s still one more savings step you should take, and it has to do with retirement.

If you’re drowning in debt, retirement may seem like it’s a long way off. But think of this: If you are eligible for the company match in your 401(k), make saving enough to meet that match your second priority.

There are lots of reasons why.

First, money deposited in your retirement account is generally safe from all creditors. (If you lose your battle with debt, you’ll still have this money saved and in reserve.) Secondly, you’re getting free money from your employer. With all that debt, you may feel like you’re treading water, or drowning, but now you’re technically getting ahead each month. You’re not only saving, but someone (your employer) is in the fight with you because they are potentially doubling your contributions with their match. Third, retirement account money isn’t merely saved, it’s invested, so you are almost certainly compounding your savings with interest over time. This means you are drastically accelerating your savings progress, even if you are struggling month-to-month on the outside with debt.

Simply, while the rest of your fiscal life may well currently be chaotic, if you’re saving money in your 401(k), you are still winning on a key financial front.

Now, about that debt.

The worst is unsecured, high-interest debt. (Typically, credit cards.)

Again, some people fight debt for years and then end up choosing bankruptcy. My experience has been that, yes, while a definitive clean slate may feel like a relief in the short term, it can haunt you for a decade. So, depending on your situation, it’s usually much better, if at all possible, to eliminate the debt through planning and budgeting.

It can be done.

I understand that it may seem insurmountable, but it’s also possible that you are too close to your own financial situation to see a way out.

Two schools of thought on debt.

The first, the "snowball method," means that you use all your discretionary income to attack the smallest card balance or obligation first, regardless of the interest rate, while paying the minimum amount everywhere else. This allows you to quickly knock out a monthly payment, it feels great, and then you immediately move your attack to the next largest (and most manageable) obligation.

Financially, however, it makes the most sense to tackle the highest interest rate debts first (this is the "avalanche method"). Accruing $400 in interest per month on a credit card is like having a fire pit that uses your cash for fuel. Cutting that in half not only saves you about $2400 a year, it’ll raise your credit score.

I met with someone recently who was in dangerous credit card debt territory. It had never occurred to him to apply for some new cards with introductory zero percent interest rates for balance transfers, or to find a lower-interest personal loan.

Sometimes we are just too busy staying afloat to see the shore.

In the end, 50% of his debt got transferred to zero interest cards, and just over six months later he’d nearly halved his original $36,000 debt, while saving several thousand in interest in the process.

Finding a balance.

Once you eliminate the worst, high-interest debt, then you need to reevaluate your plan to find equilibrium between saving more and paying off your other debt. This would mean upping your retirement account contributions, padding your emergency savings fund, and paying down debt obligations with lower interest rates, such as your mortgage, student loans and car payments.

Obviously, the process I’ve outlined here is among the most complex financial challenges anyone can face. It’s anything but easy.

But you seem to have come to terms with your situation.

I wish you luck.

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