Y’all know by now my answer to most financial debates is that the emotions beat out the math, but there’s one thing that always trumps that which I haven’t been the greatest about voicing. Partly because I thought it was obvious, but also because I forget just how nasty the debt industry can be!
This Q&A I just had with a reader covers it pretty well, so I’m just going to share it here for everyone to see, and so that I also have a place to point people to in future discussions as well.
There IS a caveat to the savings vs debt hierarchy, so hopefully this clears it up a little!
One personal finance question that I keeping struggling with is the debt vs savings hierarchy. Your recent posts that cover the concept of emotions vs numbers are making me evaluate this even further.
My general theory with the hierarchy of savings:
- Emergency fund (3-6 months or whatever your school of thought is there)
- Meet your 401k match, if applicable
- Pay down high interest debt
I know the hierarchy continues on, but step 3 will hold me up for a while. This is also where my numbers vs emotions issue arises. The combination of establishing an emergency fund and contributing 6% to my 401k (my firm matches 50% per dollar up to 6% of salary) leaves little excess for paying down my credit cards. At this rate, my emergency fund will be at a solid point within the next 6 months or so.
However… My 13k in credit card debt will continue to bitch slap me until I can tack on emergency savings to my monthly payments. I’m currently putting about $1,000 a month towards savings and 401k, with around $500 to credit cards. $1,500 towards my credit cards would feel so much nicer than only $500.
Emotionally, I want to increase our emergency savings so that my wife and I have stability. Mathematically – and – emotionally, I want to contribute 6% to my 401k. Mathematically, I want to get out of credit card debt as quickly as possible (duh).
A little back story:
- I bought a house with my wife last summer ($1,800 per month)
- I’m a 4th year accountant (yes… I see the irony here)
- Emergency savings goal is around $18k and we are about $10k away from that. We add $1,100 per month ($600 from me and $500 from her)
- I currently lease a Mercedes with a hefty payment, but fortunately this ends in a few months ($718 per month)
- 401k contribution is 6% to a traditional account ($80k salary) and my wife makes about $50k with no retirement account. I had 6% to my Roth but changed it to traditional today, that way I increase my take home a bit
- $13k in my own credit cards (mostly racked up prior to getting married)
Two more critical points:
- My wife is unaware of this debt. We have joint accounts but also some separate accounts – I use my separate accounts to pay towards the cards. When she asked about my credit cards, I panicked and said $3k instead of the actual amount (I think it was 15-18 at the time). Now I can’t bring myself to tell her how I lied in the first place.
- We will likely start trying to have kids this summer (her timeline based on age, not my ideal timeline for obvious financial reasons)
Last critical point – I do not use credit cards any more. They are all in my night stand and have no current use. I have resolved at least 90% of my bad spending habits (bars, restaurants, strip clubs, clothes and shoes) and now consider myself to be quite frugal. My largest expenses are essentially my mortgage and paying off previous mistakes (credit cards and large lease payment).
With all that said, what are your thoughts? How do I battle 20%+ interest against emergency funds for my family and retirement accounts for my family? I understand that this is an extreme situation and I’m not handling it correctly by lying, but I also like the similarities and differences with this vs the couple contemplating paying down their mortgage.
The argument with this case is still math vs emotions, but flipped into a completely different situation. Should I continue to build my emergency fund, contribute to maximize my firm matching, and whittle away at my debt?
And here was my response to him :)
I desperately want you to fess up to your wife about the debt (it’ll make for quite the come back story too!!!) but I know that’s not what you’re asking about with this email, so I’ll jump right into the question at hand ;) And fortunately, I have an easy answer for you:
20% interest trumps everything!!!
Most times when people are going back and forth it’s because the upside (or downsides) are too similar, thus making it harder to decide and why the *emotional* route then becomes the clear answer (if you’re anything like me, anyways).
But when it comes to one side being drastically different like in the case of 20% debt interest (outrageous!!!), then the tables turn and you do everything in your power to kill that junk once and for all. And even better that you’ve already nixed the habits that got you there in the first place, so you’ll be done with it FOR REAL! (Most people only focus on the *numbers* and not what got them in the hot mess to begin with)
So my personal opinion is to keep putting in the 6% towards 401k since it’s free money and you already love it both emotionally and mathematically, but then direct *all the rest* of your money right to that debt until it’s finally gone once and for all.
Which can be turbocharged even more once that Benz payment goes away as well!! (Or maybe you can use that $$$ for continuing to fill up the E. Fund and win in both areas??)
It’ll suck not doing things “in order” of your hierarchy there – which is also typically how I list them out too – but again – some things trump everything, and 20% interest is ridiculous. Odds are you’ll prob be fine with $8k banked for emergencies anyways, and if not, you can always redirect it from that month forward since nothing is ever permanent!
Anyways, those are my thoughts :)
*HOW* you’d redirect all that money without your wife asking questions I’m not sure, but if there was ever a time to fess up, now would be the perfect time! Especially if you just come out with it as open and honestly as you have with me/us here and just admit you were too ashamed to share the real numbers…
Plus, you’ve CHANGED! And you’re already halfway through the plan of nixing that nonsense once and for all! She’ll still be upset for the lying of course, but at least you’re already taking action and proving you’re serious about it unlike others who continue to kid themselves…
At any rate, I hope this gives you more to think about, and as I like to say – **as long as your money is trending UP in general**, you’re already on the right path and the rest is just amplification.
It’s great to optimize, but try not to get too hard on yourself as you’ve already had quite the nice turnaround… And thanks for making me almost spit out my coffee this morning too with your “strip club” line, haha… Too early for that stuff!
What says the
peanut penny gallery? Where would you prioritize the debt in this hierarchy?
***UPDATE*** Johnny told his wife!! And she popped into the comments section to say a few words :)
PS: This high % card also plays in the other direction too. If you were getting 20%+ guaranteed returns in saving or investing (and key being *guaranteed*), then you’d want to shift your game plan there as well. Which is pretty much why you always see “invest in your 401k” up high on these lists since the matches are not only FREE money, but an incredibly high % of it at that! (Typically around 50 to 100%).
*Name has been changed to not get our “Johnny” in trouble here… Which is an alias I always use for people who were trouble makers back in the day, since I *too* used to use it whenever I knew ahead of time I would be causing some ;) (I went as “Johnny Love” to be exact – hah)