When it comes to saving money, paying off debt and investing there are many different views on how and when each should be done. I personally believe that there is not a set in stone, one size fits all solution for saving, debt and investing. I believe that the best system is the system that works for you with the caveat that a few principles should be followed.
Let’s start with savings. I think it would be safe to say that most people believe you should have some form of emergency fund. While most agree with having an emergency fund there is a lot of debate on how big it should be. For instance, Dave Ramsey believes that if you have debt your emergency fund should be $1,000 until you get out of debt. The most common amount I hear is three to six months of living expenses for an emergency fund. Some will say that an emergency fund should be six to twelve months of expenses or even more. This is where I believe your personal circumstances comes into play. I keep between one and two months of expenses in savings. It will vary depending on my current circumstances. Eventually, I will increase the amount in my emergency fund when I get more of my debt paid down. For me, an emergency fund of $1,000 is not enough. Sorry Dave Ramsey, but I need a little bit more in savings to make me comfortable. I have been burned in the past by not having enough money in savings to cover emergencies. I do not want this to happen again. Some people may have a really stable job so they can have a smaller emergency fund. Some may not have a stable job and would want a larger emergency fund. From my point of view, everyone should have an emergency fund but each individual should tailor their emergency fund to fit their circumstances.
Now we move on to the topic of debt. Some hate debt and avoid it all costs. Dave Ramsey hates debt and does not want people to have debt other than a mortgage. He believes debt should be attacked and paid off as fast as possible. He prioritizes paying off debt over saving and investing. He believes you should live as frugal as possible until all debt is paid off, eat rice and beans and beans and rice. He wants his followers to sell everything to pay down debt. Some believe debt is a necessary tool to build wealth. Many believe, especially with the low interest rates at this time, it is a smart move to borrow money at a low interest rate and invest it because they believe that they can make more on their investments than they would pay in interest. From a logical perspective this makes sense. Leveraging debt to increase your wealth takes discipline. It is not for everyone. The same is true for using credit cards. Logically, it makes sense to use credit cards, reap the rewards while paying off the bill every month before interest accrues. This takes discipline. Many fall into the trap of using credit cards to buy things they can’t afford and wind up paying huge amounts of money in interest. In my current situation I am trying to pay off all of my debts. It will take me about 3 years to pay off my debts not including my mortgage. In about six years I should be completely debt free. This is a somewhat conservative time frame. I have no plans to add any debt now or in the future. I currently do not have any credit cards either. I do not plan on getting a credit card in the near term but may reconsider once my debts are more under control. Debt can be good or bad. It can be a tool for creating wealth or destroying wealth. It is important to understand this before using debt. For me, using debt as an emergency fund was very costly. It altered my financial path drastically and severely delayed my ability to build wealth.
Now let’s talk about when to start investing and how much to invest. There is a large group of people, with Dave Ramsey at the forefront, that believe you should not invest at all until you are debt free except for a mortgage. Paying off debt gives you a guaranteed rate of return. This is especially helpful with high interest debt such as credit card debt. Investing does involve some level of risk and the rate of return is not guaranteed. So paying off debt before investing does make sense for some people. On the other hand others believe you should start investing as soon as possible. Compounding interest takes time to see results so the sooner you start the better off you are. Investing also provides the opportunity to make returns greater than what you are paying in interest on debt. There are logical reasons for both sides. I have chosen to invest a little while paying down debt. My investing currently is about 5.5% of my gross income, 4% to my 401k and then the rest is spread out between my IRA, Roth IRA and taxable brokerage account. This is a small amount to invest considering most experts suggest to invest 15% to 20%. My main focus is on paying down debt. Once I pay down my debt I will increase the amount that I invest. I believe that this approach is best for me and my situation. I want to retire in a little less than 10 years so I believe that I need to be investing at least a little bit now in order to grow my nest egg but I still keep my main focus on paying down debt.
Personal finance is personal. I have tailored my financial plan to fit my personal situation. I know that my plan does not reflect the teachings of many well known personal finance pundits. I am okay with that. I have been following my plan for a little more than a year now and I am happy with the progress I have been making towards my goals. I have an emergency fund that is big enough to give me peace of mind that I can handle an emergency when it arises. My debt is going down at a steady pace. My investments have provided me with a great return over the past year and the accounts continue to grow. Over the past year I have established good habits when it comes to saving, paying down debt and investing. I continue to build on these habits to find ways to save more, pay down more debt and invest more. Many people are willing to give advice on personal finance. I took bits and pieces of advice from many to create my own strategy. In my opinion, it is best for individuals to adapt their financial plans to their individual needs and goals.
*Disclaimer – I am not a financial professional. The information shared here should not be considered financial advice. I am just a factory worker sharing my experience as I strive to achieve financial freedom. Before investing or making any financial decision do your own research and due diligence and consider seeking the advice of a financial and/or tax professional.
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BCB,
I can definitely say we walked on a similar path but I’m just a few years ahead of you. My emergency savings started off as $1,000 and eventually grew to 2 months of expenses. Even after paying off debt I still keep it at 2 months and prefer to grow passive income.
Keep the faith, and once you cross that finish line things will change for the better at a much faster clip.
Thanks for your support, it is truly appreciated. I look forward to the day when I am debt free and can focus more on savings and building more passive income.
I’m in the hate-debt camp, with two exceptions. For many of us, a car is essential to employment — even those working at minimum wage, where it’s often referred to as “reliable transportation” in the want ads. That is, you can’t get a job without one.
The mortgage, then, as debt comes later, after you’ve built up a down payment.
I’d also say that $1,000 in an emergency fund is way too low, for either renters or homebuyers. A major car repair, for instance, could easily wipe that out, and around here, it wouldn’t cover two weeks’ rent or a tenth of new shingles on the roof or a major plumbing repair.
In your budgeting models, do you build those kinds of “surprises” into your projections?
And how on earth are people working below median wage supposed to put aside 15 to 20 percent of their income?
Even for those without children, a situation that really complicates that budgeting.
Still, these are things that need to be examined and discussed. Keep up the good work!
Debt can be hard to avoid, especially for large purchases such as a house or car. Once I payoff my debt I have no plans to add any debt. This is why I have an emergency fund of more than $1,000 and I continue to grow it. I have a bucket system for my savings. I have a savings account that is for the car. This account will cover things such as emergency repairs, new tires and such. This account will also be used to purchase or make a down payment on a new vehicle in the future. I have an account for home repairs/improvements. I also have an account that is just a general emergency fund. This system works for me. It helps me save for different goals while also having the peace of mind of having funds available to handle an emergency.
I hope you can teach others to budget along the same lines. Those “emergencies” can quickly blow everything to kingdom come.