Thursday, October 23, 2014
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July Financial Fitness Challenge--Question to Save or Pay Debt Hinges on Priorities



A friend wanted a heart-to-heart recently about her budget frustrations. "Sometimes it seems like I'll never build that emergency fund," she said.

She hesitated and then went on, "I'm making minimum payments on my credit cards right now so I can save more money, and those card balances just sit there."

Uh-oh. At this point in our talk, I said something that shocked her—and it might shock you.

"You have to stop saving."

Before I say more, let's underscore a few points. The past few years have shown us all the importance of having that emergency fund. Depending on your circumstances, the conventional advice is to have three months, even as many as eight months, of expenses in a fund that's easily accessible, liquid. And that's still true.

The difference in my friend's case is that she's making minimum payments on credit card balances to enable her to save.

Financial triage

We know the term triage from medical situations. Triage describes professionals identifying and treating those who are both most in need of treatment and in a condition to benefit from treatment. It also means having to pass over others in less serious condition or else in such bad shape that intervention won't help.

Personal finance is like that at times. You have to take a hard look at your condition and the likelihood that intervention will help.

Say your goal is to have eight months' expenses saved against an economic crisis. For this example we'll make the goal $28,000 ($3,500 a month multiplied by eight months). That's a lot of money—it indeed can seem like an impossible task.

And say, at the same time, you have credit limits of $10,000 on one credit card, $7,000 on another one, and a credit union home equity line of credit of $20,000. In an emergency, you'd be able to tap these combined credit lines to the tune of $37,000—if it comes to that.

An emergency fund enables you to respond well to shifting financial circumstances.

OK, you may be protesting that those card limits aren't accurate because you have balances on the credit cards that reduce your available credit—say, $2,600 and $3,200 ($5,800 total in card debt). We'll get to that shortly.

Now, let's say you've also succeeded in scraping together $2,800 in regular savings, and you have a share certificate/CD worth $3,000 maturing in two months ($5,800 total in savings). I don't need to point out that, these days, neither your savings nor the certificate is earning much.

Are you ahead of me already?

I'm seriously suggesting that you think about using a large portion of those savings to pay off your credit cards. That's right, wipe out your savings. Temporarily.

More than math

This might sound crazy and irresponsible, but think about it. Here's what will happen:
  • You erase those credit card debts in record time. Pay off cards charging 13% in interest, and that's effectively the rate you earn on the money you invest in paying the debts—much more than you could earn in conventional savings.
  • As soon as you pay off the cards, you have access to the full credit card line of credit if you need it. And from now on, keep card use to an amount you can afford to pay off each month, unless you do confront one of those crises that demands you tap them for more.
  • Now you resume your savings plan. This time, you can be really aggressive about it because you don't have to make minimum payments anymore.
    "I'm making minimum payments so I can save money, and those card balances just sit there."

Is this plan for everyone? No. There's more than math to consider. Spenders who will only charge those cards back up should keep those emergency savings in place.

This plan also won't work for someone who needs the comfort that savings represent. A practical decision—for you—may not always make strict mathematical sense. Maybe this kind of saver can find a middle ground and devote half of savings to retiring debt.

And let me emphasize: This only applies to your short- and medium- term saving goals. You will not stop making contributions to your 401(k) or whatever other retirement savings tool or tools you have in place, although you might not max out contributions for the time being. Always make the minimum contribution that will qualify for the employer match.

Over time, as you fulfill other financial priorities, steadily increase the percentage you contribute to your retirement goals. This comes back to the triage idea—the retirement "patient" needs long-term, consistent care.

Sustainable balance

It's a fact of life that competing needs can make it really hard to make financial decisions. Very few of us have the luxury of not having to sacrifice in one area to address other areas—we have to balance competing demands and resources. And those demands and resources shift over a lifetime, often without warning.

The whole point of having an emergency fund, shored up by lines of credit, is to be able to respond well to shifting financial circumstances. The ideal situation, the one that provides the most flexibility, is to have both a fully topped-off emergency fund and a line or lines of credit. It takes time and patience—and consistency—to achieve that goal.

Think about wiping out your savings. Temporarily.

Financial Fitness Challenge

The people at your credit union are serious about helping you achieve that kind of sustainable balance. They bring you this website and other tools to help you make the most of your financial resources. The Financial Fitness Challenge continues to look at ways you can make better financial habits no matter what condition the economy is in.

Each month we randomly select five winners to receive $50 Visa gift cards; we choose each month's winners only from that month's entries, so enter often. Remember to register for the Financial Fitness Challenge.

ST
Susan Tiffany, CCUFC
askem@cuna.coop



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