Spend More on This and Less on That: 4 Money Trade-Offs to Consider
by Dana George | Updated Sept. 17, 2021 - First published on April 22, 2020
We make thousands of choices each day. These financial choices can benefit your bottom line.
There is a supremely silly game called Would You Rather that consists of people asking each other questions like, "Would you rather have your arm torn off by a gorilla or show up to a meeting wearing only your underwear?"
The truth is, many of us play a real-life version of Would You Rather every day, particularly when it comes to our finances. Most of us aren't rolling in enough money to buy everything our hearts desire. We must make decisions, trading one purchase for another, choosing one investment over another.
Here are some examples of financial Would You Rather. We'll call ours Should You Rather.
1. Pay off a personal loan or build an emergency fund?
If COVID-19 has taught us anything, it's that we need enough money in our emergency funds to cover a minimum of three to six months' worth of bills. Is it going to feel good when that loan is paid off? Absolutely. But without an emergency fund, we have nothing to fall back on when economic turmoil hits. For example, no emergency fund means having trouble paying debts following a job loss or sudden illness. It can mean not having enough money to put food on the table or pay rent.
An emergency fund can be the difference between drowning in debt when unemployment benefits run out and treading water long enough to land a new job. We can work on paying off loans after we have adequately funded an emergency account in place.
Verdict: Build an emergency fund
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2. Save to buy a house or pay off credit card debt?
Credit card debt is like barnacles on the hull of a ship. It just hangs there, increasing drag and slowing us down financially. And, like barnacles, credit card debt must be deliberately removed.
When the decision between buying a home and paying off credit cards, the answer is easy. Credit card debt is a drag on finances, and paying it off should always be the priority.
Once credit cards are paid off, there is more money each month to dedicate to a house fund and, because that debt is gone, it will be easier to qualify for a mortgage. Also, since paying off credit cards will increase your credit score in the long run, you're likely to be offered a lower interest rate on your new mortgage.
Let's say you're buying a $400,000 home. You put 20% down and borrow $336,000. Your credit is so-so, and a lender offers you a fixed interest mortgage rate of 6% for 30 years. Principal and interest payments are $2,014 per month, meaning you will pay $389,216 in interest over the life of the loan.
Now, with excellent credit, a lender offers you an interest rate of 4.25%. The same loan would now have a payment of $1,653 per month, and you will pay a total of $259,050 in interest. That's a savings of $130,166 in interest -- all because you went into the loan with a strong credit score.
Verdict: Pay off credit card debt before saving for a house
Few financial questions spark the level of reaction or debate as this one. At its heart, the question of saving for retirement or a child's education is wrought with emotion, because parents love their children and want what's best for them. The reality is, though, many people are on the brink of retirement with nothing saved. Many more have some money put aside, but not enough.
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If you're young enough and disciplined enough, you can plan for both retirement and your child's education by taking advantage of 401(k)s, Roth 401(k)s, IRAs, and other retirement investments, while also putting money away in a 529 plan for education. That said, the priority should always be retirement.
Be honest with your child regarding how much you will (or will not) be able to help with tuition and let them know if you plan to assist in other ways. Assistance may involve helping them to find scholarship and grant opportunities and paying for extras when they attend school. One of the kindest things you can do for your child is to finance your retirement, so they don't feel responsible for you as you age.
Verdict: Fund retirement before your child's education
4. Save or invest?
The simple answer is both saving and investing. When you have a short-term goal, like buying a new car or taking a vacation, save for it by tucking money into your savings account. At the same time, think long-term by investing.
Your ability to invest may rest on your willingness to wait for short-term goals. Let's say you want to take a $6,000 vacation. If you save $500 per month, you will have enough to pay for the trip in 12 months. However, if you save half of that amount each month ($250) and invest the other half, you will have to wait two years for that vacation, but you will also have about $6,300 in investments (at 7% interest). Of course, investments make real money when you let them ride, rather than cashing out after two years.
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Verdict: Being willing to wait for the things you want may allow you to save and invest simultaneously
It is estimated that the average adult makes in the vicinity of 35,000 decisions each day, both consciously and subconsciously. When it comes to finances, it pays to make those decisions count.
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