When to Focus on Debt vs. Savings

A Practical Approach to Financial Balance

Natasha Martin, VP and Financial Center Manager in Austin, TX

Managing personal finances can be a tricky balancing act. On one hand, it's crucial to save for the future—whether that’s for emergencies, retirement, or a big purchase like a home. On the other hand, managing and eliminating debt is essential for financial stability and growth. Knowing when to focus on debt versus savings is an important decision that can impact your long-term financial success.

To help navigate this, many financial experts suggest following the 50/30/20 rule, a simple yet effective approach to budgeting and saving. Additionally, there are several strategies to stay on track, ensuring you make the right decisions at the right time. In this article, we’ll explore when to prioritize debt repayment, when to focus on savings, and offer practical tips on staying financially balanced.

Understanding Debt vs. Savings: Which to Prioritize?

The decision between paying down debt or saving can be complex, as it depends on several factors, including the type of debt, interest rates, and your financial goals. Here are a few key considerations to help you determine which to prioritize:

1. High-Interest Debt: Pay It Off First

When you have multiple debts, prioritizing those with high interest rates is a smart move. Credit card debt, payday loans, and personal loans typically carry much higher interest rates than student loans or mortgages. These high-interest debts can grow quickly, eating into your income and making it harder to save effectively.

By paying off high-interest debt first, you can save more money in the long run, as you’ll be avoiding the compounding costs of interest. This approach is often referred to as the "debt avalanche" method, where you focus on paying off the debt with the highest interest rate first while making minimum payments on other debts.

2. Low-Interest Debt: Balance Debt Repayment and Saving

For debts with lower interest rates, like a mortgage or student loan, you may be able to balance paying down the debt while saving for future goals. The interest rates on these types of debts are often lower than the return you might get from investing or saving in a high-yield account, so it can be beneficial to put some money toward savings and retirement accounts as well.

For example, contributing to an employer-sponsored 401(k) plan or an individual retirement account (IRA) may be more advantageous in the long term because these savings have the potential to grow over time, especially if your employer matches contributions. Meanwhile, continue making regular payments on your low-interest debts to stay on track.

3. Emergency Savings: Don’t Skip This Step

Before aggressively paying off debt, it’s wise to ensure you have an emergency savings fund. Unexpected expenses such as medical bills, car repairs, or job loss can derail even the most carefully planned budgets. Financial advisors typically recommend building an emergency fund of 3 to 6 months' worth of living expenses. 

Having an emergency fund in place allows you to handle unexpected costs without relying on credit cards or loans. Once this fund is established, you can then shift your focus to debt repayment or growing your savings further.

The 50/30/20 Rule: Achieving Financial Balance

The 50/30/20 rule is a simple budgeting framework that helps individuals balance their financial priorities, including debt repayment, savings, and day-to-day expenses. Here’s how it works:

1. 50% for Needs

The "needs" category includes essential expenses that are necessary for survival and functioning, such as:

- Housing (rent or mortgage)

- Utilities (electricity, water, gas)

- Transportation (car payment, gas, public transit)

- Groceries

- Insurance (health, auto, home)

- Minimum debt payments (credit card, loans, etc.)

Half of your income should go toward these essential expenses. This ensures that you have a solid foundation for your financial needs and are covering necessary costs without overspending.

2. 30% for Wants

The "wants" category includes non-essential expenses that improve your quality of life but are not necessary for survival. This might include:

- Dining out

- Entertainment (movies, concerts, etc.)

- Travel and vacations

- Shopping for clothes or gadgets

While these expenses are not crucial, it’s important to allocate a reasonable portion of your budget to them to maintain a healthy balance. However, if you're focusing on eliminating debt, this may be an area where you can make cuts or delays in order to free up funds for other financial goals.

3. 20% for Savings and Debt Repayment

The final 20% of your income should be directed toward savings and debt repayment. This could be a mix of:

- Contributions to an emergency fund

- Retirement savings (401(k), IRA, etc.)

- Extra payments on high-interest debt

- Long-term savings for a down payment, education, or other financial goals

If you’re aggressively paying off high-interest debt, you might direct most or all of this 20% toward debt repayment. Once the high-interest debts are under control, you can shift more of this percentage into savings and investments.

Simple Strategies to Stay on Track

Now that you have a basic understanding of when to focus on debt vs. savings and how the 50/30/20 rule works, let's dive into a few practical strategies to ensure you stay on track with your financial goals:

1. Automate Your Finances

One of the best ways to stick to a financial plan is to automate as much as possible. Set up automatic transfers from your checking account to savings accounts, retirement accounts, or debt repayment accounts. By automating these transfers, you can ensure that your savings and debt repayment goals are consistently met each month without having to manually initiate them.

Automation also helps to prevent overspending on discretionary purchases, as you’ll already have set aside money for your essential expenses and savings before you even see the rest of your income.

2. Create a Budget and Review It Regularly

A detailed budget helps you keep track of where your money is going and ensures you're adhering to the 50/30/20 rule. Whether you prefer to use pen and paper, a spreadsheet, or a budgeting app, having a system in place allows you to visually track your spending. 

Review your budget regularly to ensure you're on track. If you find that you're consistently overspending in the "wants" category or struggling to pay off debt, adjust your budget accordingly.

3. Cut Back on Non-Essential Spending

It’s easy to let small, unnecessary expenses add up over time. Consider cutting back on things like daily coffee shop visits, subscription services you don’t use, or impulsive online shopping. These small changes can make a big difference when it comes to freeing up money for debt repayment or savings.

4. Use the Debt Snowball Method for Motivation

If you're struggling with multiple debts, try the "debt snowball" method. This strategy involves paying off the smallest debt first, regardless of interest rate. Once that debt is paid off, you take the money you were using to pay off that debt and apply it to the next smallest debt, creating a "snowball" effect. This method is effective because it helps build momentum and a sense of accomplishment as you eliminate each debt.

5. Stay Focused on Long-Term Goals

Lastly, it’s essential to maintain focus on your long-term financial goals. Whether you’re working to eliminate debt or build up savings, staying committed to your goals will help you stay disciplined in the short term. Set realistic goals and celebrate small victories along the way to keep yourself motivated.

Deciding when to focus on debt vs. savings is a personal decision that depends on your individual financial situation. By following a balanced approach, using the 50/30/20 rule as a guideline, and employing strategies like automation and budgeting, you can make progress on both paying off debt and building your savings.

In the end, the key to financial health is finding the right balance for your specific circumstances, staying disciplined, and making adjustments along the way. With time and commitment, you can build a secure financial future while achieving your goals.