Should I save cash or pay off debt? When we first ask this question it can be difficult to answer. Whether you are paying off student loans, credit card debt, or a car note – this question seems to always linger. In part, it is not a difficult question to answer. Rather the difficulty lies in taking the time to assess your financial state, analyzing the totality of your financial health. Inevitably, if you are asking this ‘save’ vs. ‘pay off’ question, you have a debt to eliminate. Pay off your debt first, sort of.
Saving cash while you are in debt distorts the view of your financial security. It shifts the focus from the negative, how much you are in debt, to the positive, how much cash you can accumulate. While concentrating on the latter brings us more joy, it clouds the reality of our predicament. If you are “$X” in debt [plug in your debt figure], then focusing on the negative is a must. No matter the sum, it always takes time and a concerted effort to pay off debt. However, if you don’t concentrate on eliminating debt first you are only prolonging the reality of your current financial health.
This is not to say that you should have a lack of savings. Before you begin your debt repayment you should save one month of living expenses – including rent, food, and transportation – in order to provide yourself a reasonable cushion for unforeseen expenses and emergencies. Some personal finance professionals, such as Dave Ramsey, argue that you should first have a $1,000 emergency fund prior to paying down debt. Unfortunately, in today’s world, $1,000 can evaporate quickly. I argue that you should have one month of living expenses to provide a more realistic savings cushion. Furthermore, it will leave you invigorated to aggressively tackle your debt.
Once your emergency fund is established, your total focus should shift to eliminating debt. Postpone the “finer things” in life and be conscious of your spending. Create a conscious spending plan as recommended by Ramit Sethi, author of I Will Teach You To Be Rich. Ramit argues that you should spend your money where you see fit. Spend on the things you love and cut mercilessly everywhere else. For you, this means keeping the one or two things that will make you happy while you are in the throes of debt elimination (For me, I can’t live without my coffee).
In summary, you should save cash, but only for the short term. Once you have built up your one-month cushion, it is time to shift your focus to paying off all debts. Once your debt is paid off, it will be time to start building some serious money stacks (How To Save 88K by 30)!