In my earlier post, The Foundation To Building Wealth, I explained how the kind of wealth you build is determined by the way cash flows through your life. With that in mind, I suggested that you set a goal of Paying Yourself First at least 10%-12.5% (or 1 hour a day) of your pretax income. I received tons of great comments and some awesome questions, one of which I would like to highlight and answer in today’s blog post….
“Should I still open a retirement account and save money if I have credit card debt?”
This is a question I get all the time and my answer is:
Yes, you should absolutely open a retirement account and start saving even if you are in debt!
After more than two decades of experience teaching people about money, I have come to believe with all my heart that it’s a big mistake to put off saving money until you are debt free. If you do, you may never get started saving. And you’ll miss out on the matching contribution many employers offer on 401(k) plans.
But if you’re in credit card debt, you need a different plan. Here it is: whatever amount you decide to Pay Yourself First, split it in half. Put 50% in your retirement account and use 50% to pay off your debt. Once the debt is paid, you can revert to Paying Yourself First with the full 100%.
If you make $50,000 a year, Paying Yourself First 10% would mean setting aside $5,000 a year or $416 a month. But if you have credit card debt you’d split that in half, putting aside $208 a month and using the other $208 to pay off credit cards. This system allows lets you feel like you’re working for the future while erasing the mistakes of the past.
This is bound to motivate you and get you excited about the future. In my experience, money is as much an emotional issue as a numerical one. This approach helps you handle both at once.
I call this my “Bury the Past, Jump to the Future” system. Try it. It really works.
Exercise: The Pay Yourself First 50% Debt Paydown
How to Use It: Print out this blog post and fill in the blanks below to figure out how much money every month you can put toward your debt while still Paying Yourself First. (you can also just write this on a piece of paper if you don’t have access to a printer).
Why to Use It: It’s a fast, easy way to know exactly how much you’ll have every month to pay off your credit cards.
The Bottom Line: Dividing your money this way makes sense, because it lets you keep building for a bright future while steadily getting rid of that killer consumer debt.
When You’ve Finished the Exercise: Now start making those payments and watching your balances fall! If you have more than one card and you’re not sure which to pay first, then CLICK HERE for my easy and effective system to prioritizing your debt.
If this post helped you, please leave a comment below!
Live Rich!
David Bach
I am taking this all in but I always end up short every month, I simply can not save because just by paying my minimum amounts due on all my credit cards, student loans, mortgage, etc, I am left with nothing…. what can someone in a situation like this do until some of these things are paid off?
Thank you for answering a question that had been troubling me.
This is absolutely true! I am aggressively paying off my debt and saving! My goal is to diminish all my debt by Summer of 2013 and save more and more money as I eliminate each credit card balance. The best part is I do not have direct access to my savings account. For example, a family member asked me to loan them some funds and I thought I might as well take it from my savings and then I’ll redeposit it when they return the funds.
Fortunately I was unable to tap into my savings account with my debit card. The only way I could gain access to it was by transferring the funds to my expense account and that would take 3 business days. This concept makes it easier to discipline myself and refrain from accessing that account. Now I view the funds as obsolete once they are transferred to my savings account.
There are those times when I start to doubt whether I’m doing this correctly…shouldn’t I simply pay off my debt first and then start saving aggressively? NO!!! I need to look out for me and save for that new car, down payment, traveling or simply for a really rainy day. It makes me feel incredibly bliss to observe the growth in my savings account!
Responding to Jessica – I am taking this all in but I always end up short every month, I simply can not save because just by paying my minimum amounts due on all my credit cards, student loans, mortgage, etc, I am left with nothing…. what can someone in a situation like this do until some of these things are paid off?
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Jessica, sometimes we go through our daily routine without observing our spending habits. Let’s find ways that you can reduce your expenses to increase your cash flow. Here are some tips:
1. Your job, career or business. Is there anything you can do on a part-time basis that can generate more income? It could be an enjoyable home based task such as babysitting, cooking weekly meals for well due families, dog sitting or working in a small business as the office clerk who they only require 3 times a week for very short hours and the pay is reasonable.
2. Let’s look at your mortgage. I’m in Canada and currently banks will entice you to switch your mortgage from one bank to another and by paying the current bank the cancellation fee, all to obtain you as a client. If the interest rate is appealing it can decrease your monthly payments by $100 which gives you that extra cash to save with!
3. Credit cards. Call your bank and see if they can lower your interest rate, if not call other banks and see if they are offering a 0% interest promotional rate for a period of 6 months (Again this is currently practiced in Canada) to transfer your balance from one bank to another. This could save you A LOT of money now and in the future, which again will give you that extra bit of cash to put towards your savings account.
4. Record your daily, weekly and monthly spending habits. We all can’t help but indulge in a cup of coffee or maybe you didn’t have time to cook for lunch at work or you just didn’t feel like eating what you had at home so you ordered in. Also we as women tend to purchase unnecessary hair and makeup products. In fact we tend to go shopping far too often to purchase a similar item that we have sitting in our closet. Try to discipline yourself to control those cravings and bad habits. It may save you $20-$50 or more a month, which again will give you that extra bit of cash to put towards your savings account.
I hope that was helpful!
Cheers!
Abi
Very interesting information. Thanks David.
David, we read read all your books and enjoyed them. Have you consider writing a book for canadians or can you recommend a book for us canadians?
thanks Michael & Cindy
I started this apporach a couple years ago and I am now debt free! I am now back to contributing 12% to my 401k and feel great about my financial situation. How did I find the money? I did the following…
1. Cancelled Cable (I use netflix and an HD Antenna which is free) (Saving ~50 per month)
2. Car poolled with my wife and rode the bus for my 25 min commute. (Saving ~150 per month)
3. Bought an inexpensive car with good gas milage (Honda Fit)
(Saving ~150 per month)
4. Make my lunch every day (I eat out for lunch less than once per month)
(Saving ~100 per month)
These changes required full support from my wife who is a great partner in saving. When I tell people what I drive (proudly) sometimes people say, “You need to be paid more”. People think if you make more you need to buy more. You do not! All of the items in my list some people think as necessities. I love watching my savings grow and I am happy to sacrifice a few luxuries.
Hi Abi, I currently do mystery shopping and product tests on the weekends to make extra money as well as online surveys. I have to contribute 7% to my retirement and my employer matches 2:1, so I guess I am okay on the paying myself. It is funny because I was reading the automatic millionaire and there is nothing that I spend money on on a daily basis. I basically pay my bills and put gas in my car and buy groceries. I pack lunch and if I do not pack I do not eat because I can not afford to eat out. I do not know where I could possibly cut back anymore, I am an avid couponer and luckily won a $500.00 gift card to my grocery store which has made the grocery list disappear. As far as the mortgage I just bought my home in June (due to necessity becuase of an unfortunate fire at our apartment). Thus I do not think it would be wise to change banks already. How do you convince the credit card company to lower the interest rate??? I would really like to do that. I know I am setting myself up for a good future but I guess my question is how do I make something happen now? Between the mortgage, school loans, and credit cards I am left with nothing after all the hours and work I put in and it is depressing.
Quick question… If once I paid myself my 10% and allowed 50% of that amount toward my only debt that is on a credit card and 50% toward retirement there is still money left (every other expenses have been accounted for), what should I do with that amount?
I was thinking of keeping 25% for planning a trip and 75% toward accelerating paying of my debt… What do you think of that?
Thanks for this David and Abi. I love breaking things down from percentages to its simplest terms to make things happen financially. I love the above exercise. I am buried in credit card debt and make my living as a musician. Since my income varies, the percentages seems like it would work for me. Here is my question: Besides the retirement account, is there a recommended percentage that I should be saving in my personal savings, vacation account, and holiday account? If I use the above exercise, would I divide line ‘c’ (retirement account line) and divide it by 4? That would make 25% go to retirement fund, 25% go to personal savings, 25% into vacation account, and 25% into my holiday account. Any suggestions? Thanks so much….
Okay I am at the step where I am calling credit card companies for a lower rate, I am being told that due to some credit act, if they change it, my balance will not be effected only future purchases, so should I just transfer everything over to a new account with 0%???