Author Topic: Currently at 0% savings rate because I'm paying down debt - is this wise?  (Read 5186 times)

ImproveEveryday

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I am sitting on a decent nest egg in my savings account that is remaining stable, but I am currently (and have been for a while) boasting a whopping 0% savings rate.
Instead of letting my monthly income accumulate any more in my bank account, I am using all of it to pay down my $15,000 of debt (at 3% interest), essentially quadrupling my minimum monthly payments.

From everything I have read on this blog and the forums, I feel like I am doing the correct thing; I will probably destroy the debt within one year! But I can't help but have this nagging feeling that maybe it isn't the best idea, and that I should be putting some of that money into investments. By paying debt so aggressively, I am essentially planning to not accumulate any more money or start any investments this year.

Would you trade a year of no bank account accumulation and/or investments for getting rid of $15K of debt?

kib

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Personally I would, but that's because I have had a bad track record with investing and I'm extremely debt averse.  I love the simplicity of having no debt.  These are all emotionally based motivators, however.  I've got a couple of questions: how old are you, do you have an emergency fund, are you aiming toward FIRE?  I'm guessing people will steer you away from such aggressive debt reduction when you're only paying 3%.

Cassie

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I would pay off the debt first. It will go fast & then you can really save.

MDM

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Would you trade a year of no bank account accumulation and/or investments for getting rid of $15K of debt?
No - but at least getting rid of debt beats "not investing and also not getting rid of debt."

ImproveEveryday

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I've got a couple of questions: how old are you, do you have an emergency fund, are you aiming toward FIRE?  I'm guessing people will steer you away from such aggressive debt reduction when you're only paying 3%.
I am 25 and married. We sit on a nest egg of $20k (for emergencies, plus it is our 12-month buffer), and I totally have my sights set on FIRE. Or at least getting the groundwork laid and good habits started. If we get rid of that $15K in debt, we will be debt-free and our savings rate will go up to 50 or 60%!

lostamonkey

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I consider debt repayments to be saving as you are using your income to reduce your net worry by decreasing your liabilities.

From a math perspective, investing will yield a better return so it's the mathematically correct decision. That being said, there are definite emotional benefits to be debt free.
« Last Edit: March 07, 2015, 02:01:17 PM by lostamonkey »

Cheddar Stacker

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I've got a couple of questions: how old are you, do you have an emergency fund, are you aiming toward FIRE?  I'm guessing people will steer you away from such aggressive debt reduction when you're only paying 3%.
I am 25 and married. We sit on a nest egg of $20k (for emergencies, plus it is our 12-month buffer), and I totally have my sights set on FIRE. Or at least getting the groundwork laid and good habits started. If we get rid of that $15K in debt, we will be debt-free and our savings rate will go up to 50 or 60%!

I would rather invest, particularly enough for any employer match on a 401k. But if you're going to do it, at least go all in: Don't hold $20K cash and a 15k debt when you could have $5k cash and 0 debt. If you're gonna pay it off, do it today and then start investing tomorrow.

Retired To Win

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... if you're going to do it, at least go all in: Don't hold $20K cash and a 15k debt when you could have $5k cash and 0 debt. If you're gonna pay it off, do it today and then start investing tomorrow.

There you go!  I agree with Cheddar Stacker with one proviso: set aside enough of that cash to have an Emergency Cash Reserve that will cover at least 6 months of your basic living expenses.

Good luck.

ImproveEveryday

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Good point guys! It would be nice to just get rid of that debt in one fell swoop.  After all, even though my bank account would dwindle, its not like my net worth would be changing at all. And I do believe there would be a beneficial psychological effect. 

kib

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I liked that suggestion too but I think I'd temper it a little bit: set aside a 6 month emergency fund, throw the remainder at the debt. At that point can you back off the stock purchase a little bit while you clean up the rest of the debt, without losing the employer benefit?  I'm thinking maximize long term returns while still having a little psyche edge from killing the loans.

MLKnits

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Good point guys! It would be nice to just get rid of that debt in one fell swoop.  After all, even though my bank account would dwindle, its not like my net worth would be changing at all. And I do believe there would be a beneficial psychological effect.

And depending on the nature of the debt (eg if it's a LOC), it IS then there for emergencies and at a low interest rate--though if you don't trust yourself not to run it up again, obviously close the account once it's paid off.

Given that you can pay the whole thing off at once (or very very close to "at once"), I'd go for it. You might lose a little investment time but there's very little that I find as motivating as looking at a zero debt balance and a growing assets balance.

(Just make sure you don't fall into the "oh, paid off a huge debt! Let's celebrate with a trip to Disney!" kind of trap ;)

Prairie Stash

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+1 to all in

If FI is the goal then go for it. With dual incomes you can afford to lose your job and live without an EF.

slugline

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Keep this in mind: Paying off loan principal is a form of savings. Please don't feel like you're at a 0% savings rate. By avoiding future interest expense, the effect on your net worth is the equivalent of buying an investment with a guaranteed 3% return!

ImproveEveryday

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I don't have to worry about losing employer benefit, since I don't get any anyways! 

In all seriousness, thanks for the advice everyone. I have been thinking it over and I like the idea of paying it off fully, probably within the next few months. I'll give the nest egg a chance to grow a bit more for some extra EF cushion, then propose this idea to the spouse.

And thats an optimistic way of viewing it, Slugline!

a1smith

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You should put the money where you can get the highest return.  Paying off the debt is an effective 3% return since you are eliminating the interest payments.  My guess is your savings account is earning less.

However, investing the funds in low cost stock/bond funds/ETF's should, on average, provide > 3% over time.  My suggestion is to keep enough emergency funds in your savings account and then invest any excess above that.  Also, reduce the debt payments to the regular payment (not 4x) and take the extra 3x and invest that as well.

If the debt you had was at a higher interest rate, say 7%, then I would suggest paying down the debt first since most people are suggesting using a 5%-6% long term average for stock market returns for retirement planning.  But, since it is at 3%, investing should take priority.

Ricky

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Long term it's not going to matter. It's only 1 year and it's still a minimum of a 3% return. Foregoing one year of any return higher than 3% isn't going to hurt.

But if you have the cash already, it's a no-brainer, just pay it all off and then start investing aggressively. Or pay half off and put half towards investing.

I don't think you can go too terribly wrong either way.

Elliot

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Personally, I would have at least as much as my car an/or housing insurance deductible plus maybe the amount of your rent/mortgage in savings before dong this. After that, I would absolutely go whole hog, especially since it sounds like your timeline is less than a year.

Retire-Canada

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I agree with the idea of killing the debt with the EF. Dump the extra $5K into the market and get a line of credit for unplanned expenses you might need more in a month to cover than you income can generate.  The LOC costs you nothing when you don't need it = 99% of the time and the interest rate shouldn't be evil for the 1% of the time you need a bump in cash flow.

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lakemom

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I've got a couple of questions: how old are you, do you have an emergency fund, are you aiming toward FIRE?  I'm guessing people will steer you away from such aggressive debt reduction when you're only paying 3%.
I am 25 and married. We sit on a nest egg of $20k (for emergencies, plus it is our 12-month buffer), and I totally have my sights set on FIRE. Or at least getting the groundwork laid and good habits started. If we get rid of that $15K in debt, we will be debt-free and our savings rate will go up to 50 or 60%!

OK, so throw 15k of your 20k at your debt and wipe it out.  Take the other 5k and open a brokerage account.  For now I would keep it in a taxable account to continue to serve as your emergency fund.  Now take all the money you are throwing at debt and throw it at savings by first maxing out tax advantaged accounts (401k's, IRA's) then adding to the non retirement account.  Based on your numbers I'm thinking that you don't earn enough to max out 401k's but maybe you do.

Cheddar Stacker

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... if you're going to do it, at least go all in: Don't hold $20K cash and a 15k debt when you could have $5k cash and 0 debt. If you're gonna pay it off, do it today and then start investing tomorrow.

There you go!  I agree with Cheddar Stacker with one proviso: set aside enough of that cash to have an Emergency Cash Reserve that will cover at least 6 months of your basic living expenses.

Good luck.

Based on the numbers presented, it sounds like $5k is 3 months expenses. If so that's plenty for an EF. Add a credit card for a little safety margin, but you shouldn't need that since you can always cash out some investments in an emergency.

Bob W

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+1 pay it off now