Two of the most common pieces of financial advice you’ll hear again and again are to get rid of your debts and save for retirement. However, for many Americans, there’s only so much money to go around each month — which often means choosing to eliminate debt or save for retirement.
If you find yourself unsure of which financial goals to prioritize, you’re far from alone. The right balance between debt repayment and saving for retirement will look different for each person based on their specific circumstances, but these four tips will offer some starting guidelines.
Capitalize on Compound Interest Early
You may be tempted to put retirement savings on the back burner for now, especially if you plan to keep working for a few more decades. But there’s one very prudent reason to prioritize this early, even if you have debt: compound interest.
When interest compounds, you gain interest on your initial investment as well as the interest that principal accumulates. In other words, your interest starts to rack up interest. This has a significant impact on your nest egg come retirement time.
Let’s plug a couple scenarios into a compound interest calculator to illustrate the power of investing early. Say you invest $1,000 initially into a retirement fund at age 25, then $300 each month after that. Assuming 8 percent compound interest, you’ll have $954,328 by the time you retire at age 65.
If you put off investing until a later age — say 35 — but keep everything else the same, you’ll only have $417,882 on which to retire.
Pay Off High-Interest Debts Assertively
Next it’s time to address your high-interest debts, or those with the potential to drain the most of your income. Although compound interest can help you save for retirement, it can hurt you in the debt department — causing your balances to keep growing steadily even if you’re making minimum payments.
It makes sense to prioritize any debts with an interest rate around 10 percent or higher. This is precisely why the debt avalanche repayment method calls for throwing as much money as you can each month at your balance with the highest interest rate while paying just the minimum on the rest. Once that one is paid off, attack the next-highest interest rate and so on.
If handling repayment on your own seems out of the question, it may be time to explore more structured debt strategies. Meeting with a credit counselor is a great first step. This professional may determine you’re a good fit for a debt management plan. Taking out a debt consolidation loan is another potential option for those with a solid credit score. Through debt settlement you may be able to negotiate more favorable terms with creditors — just be sure to do your research so you know what to expect, like reading Freedom Debt Relief reviews.
Keep Building Your Emergency Fund
While contributing to retirement savings and targeting your most urgent debts, keep tucking a little bit into an emergency fund each month. This will help cushion your finances if — or really when — an unexpected expense crops up. Start by aiming for a three-month cushion, all living expenses included.
Track Your Progress with a Spreadsheet
The best way to make decisions related to saving for retirement and paying off your debts is to list them in print. Compile a spreadsheet with your concrete financial goals and your progress so far. This way you can ensure you’re balancing retirement, debt and everything else — and make adjustments as you go.
Instead of treating debt and retirement like an “either/or” proposition, design a strategy around balancing these two important facets of personal finance.