Saving Money versus Paying Off Debt

Saving money versus paying off debt is an age-old quandary that has plagued people since the advent of consumer debt. Posing the question to a group of financial planners, the responses will usually be split, roughly, down the middle. While there may be as many advocates for savings as there would be for paying down debt, the broad consensus will likely be that it really depends on the specific situation.

Much of the debt reduction argument stems from simple math.; If you hold consumer debt that costs you 15% in interest and your available savings account yields 1%, than you should pay the debt down. Even if the dollar amount gained from the 1% interest of your savings is more than the 15% loss from your debt, it is still money that you are losing unnecessarily.

Most financial planners would agree that paying off high interest consumer debt should be a primary objective for all households, especially in today’s economic environment. The gains on savings accounts are generally relatively low, and consumer debt interest rates and fees continue to rise for a lot of Canadians.; There are two instances, however, where accelerating debt reduction should probably not come at the expense of savings.

Saving for an Emergency Fund

One lesson most people can take from this economy is that nothing is certain, especially when it comes to employment. Life happens to everyone, and unexpected emergencies can interrupt your income for long periods of time. As tempting as paying off a credit card may be, in certain circumstances, having a six to twelve month cushion for meeting emergency expenses can be a more critical need. Without that cushion, one emergency could cast you into a debt spiral, or exacerbate the one you are already in. You should discuss your specific circumstances with your financial planner to determine if you fall into this category.

Retirement Savings

Unless the interest rates that you are paying on your debt is inhibiting your ability to make ends meet, you might want to think twice before sacrificing contributions to your retirement savings plan, especially an employer provided plan. Depending on your circumstances, the income tax benefits of RRSP contributions may outweigh the negative impacts of your debt. It might be better to pare your retirement contribution back a little and find other means to make debt payments. Again, a financial planner will be able to properly assess your specific situation.

For most people, the savings versus debt-payoff quandary’s solution is to arrive at some sort of balance between the two options, to gain greater control over your financial future. It makes tremendous sense to get out from underneath the weight of crushing debt, however, in these uncertain times, it can be vital to continue to weave that security blanket which might be the only layer of protection you have against an unexpected setback to your financial security.