Edited to correct mistaken math.
Deep in the bowels of the internet, we personal finance bloggers have a secret hideaway where we gather to hone our craft. In a recent discussion some of us wondered which we ought to prioritize: retirement savings or debt reduction?
This is a question that’s bugged me recently. As I’ve begun to get my finances under control, I’ve found it difficult to prioritize money allocation. Should I continue to pay down my debt? Or should I set some money aside for retirement? In our discussion, Lazy Man pointed to a CNN Money article from last spring: Which “top priority” is really no. 1? Ryan D’Agostino writes:
At my age — at any age, probably — you hear a lot of sentences that begin, “The most important thing to do with your money right now is….” They can’t all really be the most important, but certain moves can pay off more at certain times in your life. The two I’m hearing most about right now are “feed your 401(k)” and “pay off credit cards.”
I ran some numbers with the help of several financial planners, and I was surprised by the passion on both sides of the answer. In the end, though, the winning move became clear: Pay some money toward the debt and some toward the 401(k).
Actually, according to the article the mathematically smart choice in all scenarios is to pay the credit card first. However the difference in the end was slight: just $200/year over 54 months.
Should you really base this decision on such a paltry sum? Or is getting into the habit of saving the more important consideration? “Usually, when a client comes with this question, I don’t even run the numbers up front,” says Aaron Coates, a financial planner at Compass Wealth Advisors in Elkhart, Ind. and co-founder of NextGen, a group of financial planners 36 and under. “I assess where the person is behaviorally.”
Once again the answer is: do what works for you. What is going to make you happiest in the long run? Do you feel oppressed by debt? Then pay off the credit card before you begin investing. Does your lack of retirement savings make you anxious? Then save a little for retirement while working on the debt. As Mapgirl wrote in our private discussion:
I contribute 15% to my 401k and I also try to pay down my credit cards. Now that I’m settled into a good pattern of life, I am going to try and pay the cards down aggressively. If you can save and pay off the debt at the same time, might as well do both. Yes, people say you ought to pay off your debt first, but I feel better knowing that I am socking some money away too. The debt will get taken care of, but if I don’t start saving, I never will.
[CNN Money: Which "top priority" is really no. 1?]
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