Once a day or so, I’ll get a long email from someone pouring out the details of their personal finance situation. Quite often, they’ve reached an age where they’re starting to seriously worry about retirement and have realized that they’re way behind where they need to be. Usually, this revelation is coupled with an astounding debt load - quite often, they list their debts, and they add up to quite a pretty penny.
Then comes the big question: what do I do? Most of the time, the situation is salvageable, but it usually points to a path of a lot of frugality and hard work - and quietly I wonder whether they’re up to it or if they’re going to keep working until the very end of their days.
Their question usually boils down to what personal finance need do I tackle first? Should I start hacking away at all this debt, or should I start socking my cash away for retirement? It’s not an easy question, actually.
What Are The Options?
Usually, you’re asking yourself what to do with roughly 10 to 15% of your income. Should you use it to repay debt, save for retirement, or a combination?
A debt repayment plan essentially means you’ve determined an orderly plan for repaying your debts and have committed a certain amount of money each month to eliminating them. Let’s say you’ve committed $500 a month and your minimum payments are $400 - that leaves $100 as an extra payment on one of the debts after all minimum payments are handled. When you pay that one off, you still use $500 a month but your minimum payments are less, meaning you can put a larger extra payment towards the first debt.
Saving for retirement, on the other hand, means you’re committing a certain amount each week or month towards an investment account for your retirement, as discussed earlier this week.
So What Should I Do?
I don’t think the choice is necessarily one or the other. I think the best solution for someone facing debt issues and the need for retirement is a hybrid of the two.
The most important thing is to make sure you’re not throwing any money away. This means making sure you’re hitting the minimum payments on all of your debts. It also means, if you have a 401(k) plan, that you’re contributing up to your employer’s match. If you’re not doing these two things, you’re throwing money away on late fees or lost contributions - and now is not the time to be throwing money away.
The first big step is to get a grip on your spending. If you’re in a situation where you have strong retirement needs and strong debt elimination needs, you need to trim back the spending hard. Stop eating out. Cut back on or eliminate your travel. Stop shopping for entertainment’s sake. Look at your hobbies carefully. Trim any fat you can from your monthly bills. You got into this situation by overspending and the only way out is by underspending.
The next big step is to compress your debts as much as you can. Call your credit card companies and ask for some rate reductions. Do some zero percent balance transfer offers. Look for other opportunities to get those rates down, such as home equity loans or personal loans. Here are some strong tactics to use.
Next, figure out how much you need to be saving for retirement. Figure out when you want to retire and how much extra money you have each month at this point, then go to your retirement specialist at work and see what you can do. They’ll probably move you to more aggressive investments and suggest you use most of the cash for retirement. You should consider seriously working while retired.
If there’s anything left, use it to hammer on your debt repayment plan, but if there’s any real key to solving this debt versus retirement conundrum, it’s learning to live cheaper. If you don’t do that - and do it with all your heart - you’ll be working for the rest of your years.
The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com