One of the biggest challenges when it comes to managing your money is juggling financial priorities: Should you save for your own future or college for your kids? Put money in an emergency fund or pad your 401(k)? Pay down debt or save for retirement?
That last question is particularly prudent as you approach retirement age because in an ideal situation, you want to retire debt-free. You probably won’t be surprised to read that the answer is to strike a balance. How do you do that?
Break your debts down by interest rate. Your mortgage is likely a low-interest rate debt — rates right now are holding strong in the low 4% range. Auto loans and student loans, particularly if they are federal student loans and not private loans, are likely to fall into this low-rate category, too. Credit cards generally have much higher interest rates. On average, they’re running about 13% to 14%, with store-credit cards coming in an average 8% higher. Paying down your debt efficiently and inexpensively means focusing your efforts on the highest interest rates first. That will get you the biggest bang for your buck.
Do the math. I generally recommend assuming an investment return of between 6 and 8 percent when planning for retirement. Wells Fargo’s My Retirement Plan assumes a return that ranges from around 4 percent to a little over 7% In either case, you’ll note that debt on credit cards comes at a higher cost — as I said, they’re high-interest rate debts and you’re likely to pay anywhere from 9% at the low end to over 20% on a particularly costly card. Simple math, then, tells you that you’d get a better return on your money by paying off credit card debt first. Debts that fall in the low interest rate category, like your mortgage, should of course be paid, but there’s no need to throw additional money at them when you could be earning a greater return in your retirement account.
The caveat? If your employer offers matching dollars, that’s a return that’s going to beat the one you get paying off even high rate debt. A common scenario is a 50% match, which means they’ll throw in 50 cents for every dollar you contribute, up to a certain percentage of your salary. That’s a 50% return on your money – guaranteed. Take advantage.
Ask yourself whether you can do both. In the best scenario, you can find some room in your budget to pay off debt and some room in your budget to save. The best way to do that is to take a careful look at where your money is going and try to cut some expenses. (One thought: Try a month-long shopping fast. It’s a very trendy way to learn what you actually can live without.)
Take pleasure in your successes. Whether you choose to focus on paying down debt or building up your savings make sure that once a month you take a close look at how much progress you’ve made. It will bolster your confidence that you can do more.
Finally, talk to an expert. When there competing financial priorities and you’re having a tough time sorting them out, it can help to meet with a financial planner. Having an expert on call can help you put things in perspective and develop a road map to meet all of your goals.