Should you Invest or Save for Retirement While in Debt?

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in debt,Investment,Retirement

I know this is a question that a lot of people have wrangled with in their own lives. When I was struggling to find a plan for my own personal finances I took the shotgun approach. Yes I contributed some money to my 401k, some went to the kids college, a little extra went towards the debt payments and the rest went to eating out. Or some semblance of that order. It’s easy in retrospect to see what an ineffective plan that really was considering the amount of debt we were in but it begs the question. If you have outstanding debt should you invest or save for retirement? Let’s look at investing first.

How to make a Guaranteed 19% Return on your Investment

Popular personal finance personality Dave Ramsey often asks this question of his callers. “Would you take out a loan to invest in the stock market?” It’s a good question and will make you think about your finances in a different way. So think about it this way. If I have a credit card with a 19% interest rate and a balance one thing I can be guaranteed is a negative 19% rate of return on my finances month after month. Now I defy you to find an investment that will give you a positive rate of return greater than 19% year over year. Your best return of investment is getting rid of that debt which will put you in a place to get towards positive numbers.

Should I save for Retirement When I have Debt?

The answer to this question is a solid “depends.” If you are going to focus, and throw everything you’ve got at your debt I would recommend holding off on the retirement saving. You’ll be out of debt that much quicker using the power of your singular focus. In my own life nothing can beat the momentum I can build by focusing on one thing. Multitasking is much less efficient behaviorally speaking. Now if your plan is to work at your debt over a period of time greater than two years or so then it makes sense to at least put in enough money for a company match if your workplace offers that. Also bear in mind that when I talk about debt I’m referring to non house debt.

What about College for my Kids?

Honestly I would put your kids college behind your retirement. It’s going to be more important that Billy and Sally don’t have to support you in your old age than worry about you paying for their Princeton education. Put that focus to work for you get out of debt, then hit your retirement and college saving.

So what’s your plan, are you doing both or is this irrelevant because you aren’t carrying any debt. I’d love to hear your views on the matter. Thanks for stopping by and please stay tuned because Friday I’ll be posting the one thing I’ve dreamed to write since starting FiscalGeek. Ooh the suspense. See you then.

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Ken 2010/01/14 at 3:14 am

I think you can do both. I like the 75/25 method I heard somewhere. Use 75% to reduce debt and 25% to save for the future. Ithink you fund emergency fund before investing in retirement as well.
.-= Ken´s last blog ..Making Retirement Days Your Best Days =-.

paul 2010/01/14 at 8:27 am

That was Matt Jabs over at Debt Free Adventure who uses the 75/25 method. For me it dilutes the focus if you are really going to bust it. But I do agree 100% with your point about funding the emergency fund before retirement, I conveniently left that out of the mix.

[email protected] 2010/01/14 at 4:08 am

A lot too depends on the amount of debt you’re carrying relative to your income. If you’re making 100k and you have 15k in debt, you probably could balance both retirement and debt payoff. But if you’re making 50k and you have 30k in debt, you almost assuredly need to tackle the debt first. It’s a matter of survival at those numbers.

“In my own life nothing can beat the momentum I can build by focusing on one thing.”–More and more I’m thinking this is the key to accomplishing any financial goal. Heck, why stop there? ANY goal!
.-= [email protected]´s last blog ..Will A Million Dollars be Enough to Retire On? =-.

paul 2010/01/14 at 8:28 am

Very true Kevin, depends on the size of the hole and the size of your shovel.

Craig 2010/01/14 at 8:26 am

Always pay the highest interest rate debt off first and quickly but the rest you can save, I like Ken’s approach.
.-= Craig´s last blog ..Weekly Personal Finance Twitter Chat: Identity Theft =-.

The Casual Observer 2010/01/14 at 9:49 am

Very well said.

On the tangent of high credit card interest rates, I was amused by a recent radio ad for a payday loan consolidation company. Apparently you can consolidate your multiple 500% APR payday loans into one easy monthly payment (at 400%?)
.-= The Casual Observer´s last blog ..Interview with Kelly Whalen of The Centsible Life =-.

Matt Jabs 2010/01/14 at 1:12 pm

I go back and forth on using my 75/25 method or going balls out w/100% to one. After a year of analyzing these two approaches I just simply have to pay myself something… even if it’s not 25%.

Even if it’s just $25/month it is hard for me to utterly abandon the healthy practice of “always pay yourself first.” Yes, when you pay off debt you are paying yourself too… but not in a liquid form.

I liked using the 75/25 method for getting our EF up to a comfortable level. To explain further – put 100% efforts toward getting EF to $1,000. 2.) Switch to the 75/25 method until you get your EF to a level YOU are comfortable with (not one Dave Ramsey is comfortable with [I’m sure Dave would agree]) 3.) Dilute the savings further, say down to 95/5 so that you are always paying yourself at least something… just for habit forming purposes if nothing else.
.-= Matt Jabs´s last blog ..Current Giveaways on DFA ““ January 2010 =-.

Peter 2010/01/14 at 1:46 pm

I happen to like the “get out of debt first, then invest” approach. And when getting out of debt I like the “do it as fast as you can even if it means extra work” approach. 🙂

When you’re investing while paying off debt I think it dilutes how fast you can get out of debt – and have financial freedom. Just think how much money you’ll have left over to invest if you just bust the debts out first, and then invest?
.-= Peter´s last blog ..Blueprint For How To Make Money With A Blog: Money Making Ideas, Optimizing Your Site And Helpful Site Tools =-.

Lakita 2010/01/14 at 2:11 pm

It depends on a lot of factors…..primarily age. If someone is 25 and in debt, I would say focus 100% on debt elimination, unless the debt is extreme, it should be eliminated in 3-5 years. On the other hand, if the person is 45 and has no retirement savings, I would encourage something towards retirement and debt is being paid off.

paul 2010/01/14 at 2:28 pm

Thanks for all your insight folks and again this is my “personal” finance plan and it has definitely worked for me. Read on tomorrow and you’ll see how.

Lakita I’m somewhat towards your higher range and fortunately I had done some investing before so wasn’t that much of a stretch to suspend my 401k for debt busting. But if you are 25, bust it like no tomorrow then you can invest.

JoeTaxpayer 2010/01/14 at 8:50 pm

One thing I’d add to this discussion is a proposed exception. One should not walk away from an employer match on 401(k) money, especially the dollar for dollar match some offer on first X% of one’s salary.

Matt Jabs 2010/01/14 at 9:00 pm

Yeah… that is another thing I struggle with and go back & forth on. But at the end of the day I’m choosing to leave it on the table in lieu of guaranteed ROI from debt reduction.
.-= Matt Jabs´s last blog ..Current Giveaways on DFA ““ January 2010 =-.

paul 2010/01/14 at 9:13 pm

I’m with Matt, it’s what I’ve done for the time being and it’s what has allowed us to aggressively get out of our 63,000 dollar hole.

LAL 2010/01/15 at 10:41 am

Depends. Honestly if you are out in 1 year then cool, but if it takes 4-5 years?

I mean to pay off $63k in 11 months is average $5-6k/month. Very impressive. But put it into this perspective.

That’s more than the average american family makes annually, $50k/year. And that’s after tax dollars. Thus, the shovel is huge to allow for an extra $5k/month. I don’t have $5k/month even without retirement savings to pay off debt.

Thus I think people need to examine their own budgets and timelines. It’s easy to tell people to not save for retirement if you can get out of debt in less than one year. I think it’s a lot harder if you make $50k and have $50k in debt and it’ll take longer to pay off.

Either way works out.

Joe Plemon 2010/01/15 at 12:44 pm

I’m with the radically focused approach, regardless of age. The watered down approach could cause one to lose focus and certainly guarantees the “older” person that he will be in debt that much longer. If I know I need to get rid of debt before I can invest, I will rightfully be that much more motivated. Like Peter said, it may take an extra job for a couple of years, but after the debt is gone, all that had been going for the debt can now be used to pay yourself (emergency fund and retirement).

JoeTaxpayer 2010/01/15 at 12:56 pm

Too often, as an engineer and a numbers guy, I am blinded to other issues. The PF bloggers I run into here and elsewhere have opened my eyes to other views and ways of approaching issues. While my initial response may start from the same thought process, I appreciate what I’ve learned from all of you. Just saying.

paul 2010/01/15 at 1:06 pm

Thanks Joe I really appreciate it.

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