Paying Down Debt Is a Bigger Deal Than You Might Think!
Q: I recently met with a financial planner who helped me set up an RRSP with the $10,000 I received through an inheritance. The planner also encouraged me to invest the income tax refund I’ll be getting to boost my retirement savings. I have about $8,000 in credit card debt and I’m wondering if it would be better to pay down my debt with the refund instead of contributing to my RRSP?
A: This is a common dilemma today. We are constantly hearing that we need to pay down debt but at the same time we are told that we are not saving enough for retirement. It’s no wonder that many of us are confused; we stay in debt, aren’t sure how best to manage our money to reach our goals, and don’t save enough for our futures.
Paying Down Credit Card Debt Will Save You More in the Long Run
Many experts agree that when faced with the choice of paying down high interest credit card debt or contributing to an RRSP, the rewards are bigger in the long term if you pay down your high interest debt as quickly as possible. A number of reasons support this opinion:
- You’re fortunate today if you can generate a 6 – 8% return on an RRSP investment. By paying down high interest debt, you earn an equivalent rate of return of 20% or more.
- Putting more money towards paying down your debt will not only get you out of debt faster, it will save you a bundle in future interest costs and fees.
- Saving money is harder when you have debt obligations.
Review Your Spending & Expenses to Find the Money to Pay Off Debt Faster
In addition to paying down your debt with the tax refund you receive, review your monthly / irregular expenses with an eye to cutting your expenses by up to 10%. This will free up funds to pay off your debt faster. Set a get-out-of-debt-date, a “Findependence Day” as Jonathan Chevreau has called it in his book of the same name, and monitor your results to help you achieve this goal.
Savings Will Help You Deal with Unexpected Expenses
While getting out of debt should be your top priority, it’s wise to set up a small savings account to help you deal with unexpected expenses. That way you won’t need to rely on your credit cards when faced with a financial emergency. Work towards saving $1,000 - $2,000 over the next year or two, so that you are able to put most of your financial resources towards eliminating your debt.
Paying Off Debt Will Put You Further Ahead
Keep your focus on where you want to be in the future. While it’s nice to build your savings, you’ll be further ahead and find it easier to save once you’ve paid off your debts.