Save, spend or pay off debt? Where do you start when you’re finances are a bit of a mess, and you are determined to get back on track? It can be completely overwhelming trying to get started, and I think that’s why so many people delay taking that first step or fall back on bad habits after a setback. What you should know though, is that it really doesn’t need to be complicated. Yes, turning around your financial health will be tough and you’ll have to make some sacrifices, but the actual system is straightforward.
There are a lot of parts when it comes to personal finance but don’t get distracted (or overwhelmed) by all the different types of investments or styles of investing. When you’re just getting started you want to focus on the basics…paying off debt and having a solid base of savings. Everything else will fall into place after that. Experts go back and forth about whether or not you should pay off debt first or save an emergency fund first…I’m taking the debt side on this one. Emergency funds are vital, but if you are just starting out and have to make a choice, I think it’s best to get a jump on those payments and put your money towards your debt. If tragedy strikes and you have an unexpected expense, you may find yourself back where you started, either dipping into your newly funded emergency fund or charging it to your credit card. If you do have to use your card, you’ve at least saved a bit on the interest payments in the meantime.
#1 Pay Down your Debt (the high-interest stuff
Notice that this is in regards to high-interest debt so that primarily includes credit cards and unsecured lines of credit. We’ll worry about mortgages, student loans and even low-interest car loans later on. I talk more about paying down debt in this post, but I’ll recap quickly here. There are two methods for debt repayment; the first is the avalanche method where you pay off your highest interest debts first, and the second is the snowball method where you pay off your smallest debts first. Honestly, it doesn’t matter which one you choose, the important part is picking one and sticking with it.
The big advantage of paying off debts is the amount of money it frees up each month. Each account that is paid off in full means one less payment going out every month and more funds available to get ahead in the next area.
There’s one exception to the debt before saving rule, and that’s if your employer is willing to match your contributions. Saying no to that is basically throwing away free money so if your work has a group savings plan then 100% you should sign up for it.
#2 Tackle that Emergency Fund
First, go buy yourself a beer for getting your debt paid off…that’s huge! Then it’s time to refocus and switch into savings mode. Building up an emergency fund will be key to not falling back into debt when an unexpected expense crops up (because they will!) You’ll want to have about 3 months (at a minimum) of living expenses stashed away so you have a bit of breathing room if you lose your job or your dog has to go in for emergency surgery (those vet bills are killer). I like to use a no-fee, high-interest savings account for this, so you get a little interest but it is easy to access. PC Financial and Tangerine have good options. Definitely stay away from investing your emergency fund in anything risky. The whole purpose is that the money is there when you need it so tying it up in an investment that might lose money or make it harder to withdraw is not ideal.
Those first two are the biggies and the ones that will cause you the most grief if you don’t get them handled. The next points are a little more flexible, and you can mix and match depending on your comfort level and priorities. Maybe you split your extra cash equally between theses four, maybe you go with 50% towards retirement, 30% towards low-interest debt, and 10% to a big ticket item. My only stipulation, saving for retirement should be the biggest (or at least equal to the biggest) expenditure on the list. I know it’s not flashy and fun or as satisfying as paying off a loan but being old and broke isn’t what you want, and no, you aren’t going to win the lottery. Deal?
Save for Retirement
The younger you start the less you have to save thanks to the wonderful process of compounding interest. Investing even $100/month in your 20’s will make a significant difference in the amount of money you will have in retirement. If you’re jumping on the bandwagon a little late, you’ll need to save more, no question about it, but the most important thing is getting started.
Work on that Low-Interest Debt
This will include paying off any outstanding car loans or increasing your mortgage payments. A lot of mortgages will allow you to increase your payments by a certain amount and also put down an annual lump sum. Take advantage of this, you don’t need to do the whole amount but increasing your monthly (or even better, bi-weekly) payment by even 10% will cut down how long you’ll be paying off the mortgage and how much interest you’ll pay. The more debts you pay off in full, the more monthly income will be freed up for other things.
If you don’t have children, you can skip this point but if you do, you may want to factor RESP contributions into your monthly budget. If you want to set some money aside for your children(s) education, RESP’s are an excellent way to get an additional benefit through the available government grants. More info here.
Save for a Big Ticket Item
This could be anything from an annual vacation, to a new car, to a home reno but if you have something you want then start saving for it. And your emergency fund does not count for this! This shouldn’t be your top priority, but I’m giving you the A-Ok to put a portion of your monthly savings towards something in this category. Some people go into full gear retirement savings mode and aren’t able to get out enjoy life in the present. I like to think balance, live decently well now and decently well later instead of poorly now and fantastic later 😉
There you have it, once you get past steps one and two you will be able to create a workable budget outline to get you ahead of the game. There’s also room for flexibility so if your priorities change (say you have a baby) you can change up your proportions or add amounts if you come into some moula. Happy saving!