This week’s edition 0f Beyond the Cupola was previously written by Kenturah Orji, an intern in the Oconee State Financial Services department. 

We are often told how important it is to save for retirement, but it is also stressed to pay off debt. We have limited money and resources, so the questions we often find ourselves asking are:

• Which goal is more important?

• How should I divide my extra income between these two important financial goals?

• How much of my income should I apply towards meeting these goals

Before allocating any extra money to retirement or debt, it is important to first build an emergency fund or cash reserve. This is crucial for unexpected expenses that may occur and will keep you on-track towards meeting your goals once it has been established.  By maintaining an emergency fund in savings (6 months of expenses), you won’t have to alter your financial savings if a one-time expense arises.

A good rule of thumb is to save 10-15% of your income for retirement while also utilizing at least 20% of income to pay down debts. For example, if you earn $4,000/mo: $800 would go towards paying off debt and $600 would go towards retirement. If you have additional money to allocate, the correct allocation of funds would depend on your situation. Here are 5 keys to help you make smart financial decisions:

Always Consider Rate of Return

If you are receiving a higher rate of return in your investment account than you’re paying interest on your debt, it is definitely better to apply that extra income to retirement. For example:  your investment account is earning 8% per year and you’re paying 4% per year interest on a loan – this would make sense to save additional money towards investments.

Student Loans Don’t Always Come First

Younger people are usually focused on paying off student loans right away, but the power of compounding (concept that exemplifies the more time you have to invest, the more money you earn) is irrefutable. If you can pay off student loans within a short time horizon, it is fine to take a backseat in saving for retirement. If you have a large student loan debt (or any other debt) that will take longer to pay off, it is not worth waiting to start saving for retirement. Start now and take advantage of your younger age and investment time horizon – time is your friend in the investment world!

Interest vs Principal

If you are nearing retirement, most of your loans are probably near the end of their life, so the interest in the account has mostly been paid. Loans are typically front-loaded with the interest and the back end is mostly principal. Meaning that you are paying more interest than principal to in the beginning and vice-versa towards the end.  In this situation, it would be best for money to go towards retirement saving versus paying off debt.

Avoid High Interest

If you have a lot of credit card debt built up, work on paying credit cards off first before saving for your retirement goals. This is primarily due to the high interest rates charged on credit card debt.  You will unlikely earn enough to beat the interest being charged with investment earnings year over year.