Should You Pay Off Debt or Invest in Savings?

Editor's Note: Dealing with current debt is a reality for many people. The challenge is to eliminate debt and at the same time grow your personal investment portfolio. Alanna does a great job of dealing with this issue.

In May of this year, the Federal Reserve Bank of New York reported that U.S. consumer debt totaled $11.23 trillion. If you are examining your personal financial situation to handle your share of this debt, you are taking the right step.

Managing your income properly requires an approach that is threefold, as you must look at what you owe today, how emergencies can impact your life and what you will be able to invest in to achieve retirement goals.

1. Handle high interest debt immediately. Credit card debt or loans with high interest rates have a tendency to drain even a solid income. Ignoring these debts or taking a haphazard approach to on-time payments can allow the problem to worsen, costing you more and more in interest and late fees. Start by making minimum payments on all the accounts you owe to put the accounts in good standing, which can eventually help your credit score improve.

There are two main schools of thought on which debts to pay off first, but there is a principle we can glean from both of them. One recommends paying off the account with the lowest balance first, which can seem easier and decreases the amount of open negative accounts. The other recommends paying off the account with the higher interest rate first.

Both of these strategies improve debt management as they approach debts by focusing on a specific problem and making an effort to pay more than the minimum payment on an account.

2. Put Together An Emergency Fund

Having savings for retirement is a goal to work toward after you have made a dent in your debt. Right now though, build up an emergency savings account of at least 3 months of after tax income. Your intention is to get out of debt and stay out of debt, so you need a cushion to soften any unexpected financial crisis.

Vehicles may suddenly require expensive maintenance. Costly medical issues can disrupt your life out of nowhere. You may encounter periods of unemployment or face increasing monthly rental payments. Being able to turn to an emergency fund in any of these situations can keep you from relying on credit or having to skip making your monthly loan payments.

3. Profit from Your Discretionary Income

Your discretionary income consists of the money you have after basic living expenses are subtracted based on the poverty line. What this means is taking your paycheck, subtracting regular necessary costs, then looking at what remains.

Once you have accomplished the goals of regularly paying on debts (including paying more on at least on accounts) and building an emergency account, you can pursue investing in any extra money from your discretionary income into savings.

You can begin with a traditional savings account that will earn a percentage on the money you deposit into it and also see what programs your job has to offer. There may be a 401(k) or other type of retirement account that will increase at a more rapid rate than your bank offers.

Research all of these options, while realistically considering how much you will be able to consistently set aside every paycheck.

Alanna Ritchie is a content writer for Debt.org, where she writes about personal finance and little smart ways to spend (and save) money. Alanna has an English degree from Rollins College.

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