We talked on a recent podcast about whether or not paying down debt counts as saving money. They are both equally important financial habits to form. But the resounding answer was no it does not.
If you’re reading this blog post, you likely have debt. (Or at least have had debt at some point in your life.) Whether it’s buying a home, going to college, buying a car, or making purchases on a credit card, there is a high probability of taking on debt as you move through adulthood into retirement.
Both paying down debt and saving money should be counted as expenses.
They are (likely) the two most important expenses in a monthly budget. But both of these expenses affect different sides of your net worth.
Saving money, whether that be for retirement or otherwise, increases your ability to spend money in the future. You have more purchasing power in the future because of what you save today. And even more purchasing power, if you invest that money. We’ve covered why that’s important for retirement here and here.
Paying down debt, on the other hand, decreases the amount you owe. It ultimately has a similar future affect, especially if you eliminate the debt. You will have more money to spend in the future when you aren’t responsible for those payments anymore.
We recommend that folks maintain a personal net worth statement so you can keep track of your progress in both of these departments. We all agreed on the podcast that it’s important to have a tangible representation of your progress toward financial goals. The feeling of progression is a major motivating factor! So here’s how you do it:
Calculating your net worth is like taking a snapshot of your assets and your liabilities.
- Assets = what you own
- Liabilities = what you owe
- Net Worth = Assets – Liabilities
Here is what you should include in your assets:
- Checking accounts
- Savings accounts
- CDs (certificates of deposit)
- Other cash
- Investments (stocks, bonds, mutual funds, include retirement accounts)
- Property (market value of your home, investment properties, and your vehicle)
Here is what you should include in your liabilities:
- Auto loans
- Credit card debt
- Consumer loans
- Student loans
- Other outstanding debt
Subtract your assets from your liabilities and BOOM you’ve got your net worth.
Saving money affects your assets, while paying down debt affects your liabilities. Again, both really good things. But very different.
Owing less in the future is not the same as having money to spend today.
Having money in a savings account gives you the peace of mind of having it on hand. It gives you security and flexibility. You know that, in a pinch, you can access it and cover expenses. It gives you flexibility because you get to determine 1.) where to save it (checking account, savings account, investment account or retirement account) and 2.) how to spend it. It’s liquid. It’s readily available for you with no strings attached.
You can’t tap into a liability in a pinch. Actually quite the opposite. Liabilities decrease security and flexibility in the present. If your income gets interrupted somehow, the liabilities don’t go away. You are still responsible for making the payments. And there are consequences if you don’t. It’s a trade off. You sacrifice financial flexibility today, for the ability to do something you otherwise wouldn’t be able to do.
Paying down debt is really good for your future self, but it is not the same as saving money.
The context of this question is typically posed as, “well what should I do first, save money or pay down debt?”. And the answer is usually both at the same time.
Of course, personal preference comes into play as well. But there’s a misconception out there passed around by some financial “experts” that you have to have all your ducks in a row before you buy a house, invest in stocks, save for retirement etc. etc.
You should never take on more debt than you can handle based on your income level. You should always be able to at least make the minimum payments each month. But it is possible to save money and pay down debt at the same time.
Start small. Start little by little. Piece by piece. But most importantly, start today.