Focusing on Debt
Learn strategies for managing debt and building wealth
By Micah Odom
Which is more important: paying off debt or saving for the future?
When you’ve started earning a steady income, but you’re still paying off hefty student loans, it can be hard to figure out which should come first. Paying off your debt as fast as possible may seem like the responsible thing to do. However, sacrificing savings for your future could leave your finances at a permanent disadvantage down the road.
Business owners often find themselves in a position of making critical financial decisions that have lasting effects on the business and their personal financial future. Particularly when it comes to debt, making wise decisions is critical for both your personal and business finances. This article explores some of the primary financial decisions you may encounter when managing debt and what impact different courses of action may have.
PAYING DOWN DEBT VS INVESTING EXCESS FUNDS
If you have multiple financial goals, you might wonder if it’s best to put extra money toward your debt (mortgage, loans, etc.) or to increase your investment dollars. Here are a few things to keep in mind as you define your priorities:
- Stay on Track. Your vision of retirement is unique, and so is your path to get there. In general, it’s more important to be on track with your retirement saving goals before you pay down a mortgage. Being “on track” means you’re saving enough to meet your retirement needs.
- Know the trade-offs. What are the trade-offs between paying down debt and investing for your other goals? A financial professional can illustrate different scenarios for you, helping you prioritize and balance your goals based on what is most important to you.
- Build emergency savings. Ensure you have three to six months’ worth of expenses in emergency savings. This amount can help you manage unexpected, large expenses (or unemployment) without having to dip into your retirement savings. It can also provide flexibility to do the things you want to do, such as switching careers or taking time off to care for a loved one.
- Assess your debt. If your debt balances cause you stress, you may want to consider paying them down. The goal is to be comfortable with the amount of debt you are carrying.
Setting your goals is not a one-time process. Your financial priorities will likely change over time, and your strategy should as well.
Though it’s a personal decision, starting early with investing could benefit you in the long run. As Figure 1 illustrates, you could end up with nearly $200,000 more if you start investing the same amount each month at age 30 instead of 33.
Figure 1 depicts an investment of the same amount each month at different age levels. The example assumes investing $6,000 a year, plus an additional $1,000 catch-up contribution at age 50 and older, with a hypothetical 7% average annual return. Starting to invest at age 30 vs. 33 gives you $193,000 more. Starting at age 35 vs. 38 gives you $137,000 more. Starting at age 40 vs. 43 gives you $98,000 more. By starting at age 30 instead of age 43, you would earn $613,000 more in this example.
You may ask, what is this ratio, and how does it apply to me? Your debt-to-income (DTI) ratio can be a predictor of your financial health. The higher the number, the higher the percentage of income being used to pay off debt. If you’re paying a mortgage, try to keep your DTI ratio at 35% or less. (Without a mortgage, strive for 20% or less.) A higher DTI ratio may constrain your budget, making it difficult to purchase a home, and force you to accept higher interest rates.
GET STARTED WITH FINANCIAL HEALTH
Starting and running your own business is a life achievement. While working to build a healthy, thriving business, work to build a healthy, thriving financial future for yourself. Set goals, review them with a financial professional, and weigh the risks and benefits of different approaches to managing debt to help you achieve your financial goals.
Micah Odom is a Financial Advisor, located in and serving the Greater New Orleans Area. She is a proud Louisiana State University Alumnus. Micah is passionate about partnering with people and their families on their finances and loves to serve as an educational resource as well.