Kathleen talks a lot about saving half of your income and why you should be doing it. I’ve been reading along with those posts for a while now, and I totally understand the reasoning behind her logic. But I never thought I’d reach the point where I could “save” 50% of my income. After all, I’m still pretty deep in debt, and I’m currently throwing around 50% of my monthly income toward debt.
Then I re-read this post of Kathleen’s where she said that paying off debt kind of counts as saving when you are tallying up to reach your 50% savings rate. Of course there are exceptions to this rule, like if you continue to spend on your credit card and are just paying that off each month you are not making any progress on your debt, therefore you are not “saving” that money.
I also realized that for those of us in debt who are putting 50% toward debt each month, we are making more progress than those who are debt free and saving 50% of their income. Here’s why.
I bet you didn’t see that one coming. (Just kidding!) We all know how detrimental high interest debt is to your financial progress. After all, it’s pretty hard to make any progress with paying off a debt if you only pay the minimum payment each month and the interest rate sucks up about 90% of your payment.
But once you reach a point where you are consistently paying more than the minimum payments toward your debt each month, you progress will happen much more rapidly.
By putting 50% of your income toward debt payments each month, you are making more progress than the amount you paid.
For example, if you earn $2,000 each month and you put $1,000 toward your credit card debt you are putting 50% toward debt. That’s easy enough to understand. But don’t forget that of that $1,000 you paid toward debt it didn’t all go toward lowering your principal balances, some of it paid interest. Thus, less than 50% of your income was used to improve you financial position. However, the more principal you pay off, the less interest you’ll be accruing, making your payments worth more than just the amount of principal you paid off that month.
Confused? I hope not.
The point is that most forms of debt have higher interest rates than where most people store their savings. Credit card interest can be 20% or more while most savings accounts earn a maximum of about 1%, and that’s only if you have a high-yield savings account.
Of course, people can choose to store their savings in other places to earn more interest, but the options are usually less liquid, making the funds difficult to access quickly for emergency purposes.
Even if your savings are in investment accounts, most of the time, they will not be earning 20% or more in interest or investment gains.
Therefore, while you are in debt, you are making more progress by putting 50% of your income toward savings than your debt-free friends are by saving their income. Just don’t use this as an excuse to stay in debt, or you won’t be progressing at all. :)