Have you ever wondered if putting all your money towards debt repayment is the best thing to do?
Most financial advisers will tell you to focus on paying off debt with the highest interest rate first. They will say things like “you’re not going to get a 19.99% return in the markets so you should focus on paying your visa and save after”.
The problem is that this almost never works. Most people feel so good about paying off their debt, they just rack it up all over again to reward themselves. And I’ve worked in a bank so I’ve seen this happen over and over.
While I agree that debt should be a focus, saving money should be more important for those who aim to be financially independent and here’s 9 reasons why.9 Reasons Why Saving Is More Important Than Paying Off Debt Click To Tweet
1. No Savings Means No Choice
Allow me to paint a picture for you using two examples. Let’s say we have 2 individuals that both get laid off.
Individual number 1 is a saver and individual number 2 is focussed on debt repayment. They work at the same company, have the same salary (let’s say $50,000 annually after taxes), and both start off with the same debt (let’s say $25,000).
Both of them work for 1 full year. Each manage to put 50% (25,000) of their income towards their networth. Suddenly they both get laid off. On the day they get laid off, and based on the way they decided to manage their money, here’s where each stand financially.
Individual #1: He has been consistently saving 30% of his income while steadily paying down debt. He saved $15,000 during the course of the year and he’s also been investing it and earned a 10% return, so now he has $16,500.
As for debt, he’s been making all the required payments and has paid off $10,000. So when individual #1 gets laid off, he owes approximately $15000 to $16,000 (based off whatever interest rate) in debt but has $16,500 in the bank leaving him with a positive net worth.
He’s not too worried about the fact that he got laid off because he’s got some savings to fall back on and can afford the minimum payments to keep reducing his debt. He takes his time looking for a job and finds one he really enjoys.
Individual #2: He has put his entire $25,000 towards his debt and is very proud that he paid it off, until he got laid off. On this day he realizes that he has no options because he’s got nothing in the bank.
Not only is his net worth $0, he also has to go back into debt while he searches for a job. Even worse, he might not even have the credit available since he’s been avoiding credit cards and debt.
Now he has no job and no one will approve him for a loan. He starts panicking and takes the first job opportunity that comes his way, even though it makes him miserable.
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffet
2. No Savings Leaves You Unprepared For Opportunity
What are you going to do when the market takes a dive and opportunities are everywhere if you don’t save? What about if the housing market takes a dive and that property you’ve had your eye on is ripe for the taking?
Or maybe you’ve always wanted to become an entrepreneur and you finally have a great idea, but have no money to finance it. You need to save for when the opportunity arrives, and it will come.
There’s a certain level of comfort you experience when you’ve got some money in the bank. Your bosses threats mean a little bit less. You sleep better at night. You feel more in control of the direction of your life. It’s simply less stressful.
4. Saving Is Rewarding
If you only focus on debt repayment, like in the example I listed above, you could end up at a $0 net worth. Even after making all that progress you feel like you’ve accomplished nothing.
On the other hand, if you save, a day will come when you look at your investments in amazement of how much you have. It’s progressive and much more motivating to see your account grow, rather than see your debt be a little bit less.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
5. Compound Interest
I’m just gonna come out and say it, most people just flat out don’t have a fucking clue when it comes to understanding the concept compound interest.
Yes, when you start saving you receive small amounts of interest/dividends/growth. But, if you’re consistent, over a 5-10 year time frame with your saving, then you’ll definitely begin to see its potency. You get paid interest on interest and it snowballs. Don’t miss out on compound interest because of debt.
6. You Can Do Both
I’m not saying to make the minimum payment on your visa and then hoard as much of your next pay cheque as possible. I’m saying I think saving is more important and I’m the proof.
I’ve been saving and building my portfolio for years now, and I’ve also been paying off a lot of debt.
Like every other student alive, I’ve been spending the last few years paying off my student loan. I’ve paid off about half of my loan and continue to make payments to this date.
If I had of went the other route, and only focused on paying off the loan, then I might have missed the opportunity to start working from home and this blog might not exist.
Decide on a savings amount and make it automatic each pay. After you’ve decided on how much you’ll save, create a plan to pay off your debt. And then spend the rest and enjoy life.
7. It’s About Acquiring Assets
Those of you that have read Rich Dad Poor Dad know what I’m talking about. It’s a poor person mentality to focus on only debt repayment.
Between your mortgage, car payment, kids, and costs of marriage, most people don’t have a chance to own an asset.
Simply put, you will not be wealthy unless you own assets. In Rich Dad Poor Dad, the author Robert Kiyosaki explains the difference between the rich and the poor.
“The rich buy assets. The poor only have expenses. The middle class buys liabilities they think are assets. The poor and the middle class work for money. The rich have money work for them.” – Robert Kiyosaki
8. Savings Helps You Avoid Debt
Having money in the bank means you’re likely to rack up less debt in the first place. Having money also helps you appreciate it more because you know how hard you worked to keep it.
As a side note, though, there is good debt. For example, to grow a business, or purchase a rental property, or to utilize margin to leverage your returns.Saving Vs. Debt Repayment: Don't Underestimate The Power Of Habit Click To Tweet
I left this one last because I think it’s extremely important. So many people think, once we pay off our mortgage we’ll start saving, once the kids move out, when my visa is paid off, after this vacation and so on. Stop lying to yourself now! You’re not gonna do shit unless you start right away.
Do you really believe that after 25 years of paying your mortgage and being in debt you will all of a sudden just change? Saving is a life long habit that you absolutely must do.
And you don’t even have to put so much pressure on it. Save 1% per pay and work up from there.
When I started this journey I was saving about 35% of my income, but as we all know, life gets more expensive as you become an adult. Even with that being the case, I always make an effort to save a minimum of 10%.