Should you clear your debts first (including your mortgage) or save for retirement?
This is one of those old, on-going debates of whether or not you should clear all your debts first or save for retirement.
Personally I’d do the former.
I’d clear my debts first (every debt, including mortgages), and THEN save for retirement. I know you’d lose out on compounding interest in the time it takes to clear your debts, but here are my reasons for leaning towards debt repayment first:
1. YOU CAN LOSE YOUR INCOME AT ANY TIME
This is a big one.
You can lose your job, get hurt and not be able to work, or for any number of reasons that would prevent you from making an income.
What doesn’t change? Your expenses.
You STILL have to make that mortgage or debt payment, and you don’t have a choice.
Would you rather be in a position to have to make a smaller minimum payment on your current debt that impacts your finances NOW or would you rather feel good about having X amount in retirement savings?
2. RETIREMENT SAVINGS ARE GENERALLY LOCKED IN
I dunno about you but once I stick money in my Registered Retirement Savings Plan (RRSP), I can’t take it out.
I can borrow from it and use it for a down payment or for continuing education, and so on, but I still have to pay it ALL back within a time frame.
It’s not like I can take out the money and clear my debt in times of financial distress and feel total, utter relief.
3. YOU ARE STILL SAVING, BUT ON THE INTEREST PAYMENTS INSTEAD
Now people might feel weird because they’re not saving any money, but you kind of are.
You’re saving on having to pay extra in interest because you’re forcing the principal (main) balance down to as low as possible, which makes your interest payments lower.
5% interest payments on $100,000 (which is $5000) is very different from 5% on $10,000 (which is $500).
4. YOUR RETURNS ON INVESTMENT ARE NOT GUARANTEED
Even if you save all your money into index funds, it is for the LONG run that you will make an average of 5% – 7% as a return, but it doesn’t necessarily mean that in THIS YEAR that you are paying back your debt, you will make those returns.
For me, the surer bet is your debt repayment in terms of return on investment.
5. SAVING FOR AN EMERGENCY IS NOT THE SAME THING
Note that I didn’t say you should forgo all saving.
I still think having a little extra cash as a buffer for your bills is always a good idea.
The best example I can think of for this is if you don’t keep a cash buffer in your account, you might have a bill that automatically comes out and charges you more than it should have (!!), so it ends up setting off a nasty chain reaction of missed bill payments or insufficient funds (NSF) fees that culminate in you screaming into the phone trying to get back your money due to their screwup.
THE ONLY EXCEPTION TO THIS:
The only exception for me is if your employer matches your contribution 100%.
If your company is saying: Hey, set aside 3% of your gross income each year and we’ll fully match it with 3% of our own, THEN GO FOR IT.
It’s already a 100% return on your money, which beats out any kind of interest rate.
Anyway, the best advice I can give to you? Budget and track your expenses.