A First Foundation Blog

Should I Save, Invest, or Pay Down Debt?

| 5/27/21 10:13 AM
3 minute read
How to prioritize these important financial goals

If you find yourself with extra money in your budget, you may be wondering what’s the best plan of attack: Should you save, invest, or pay off debt? At First Foundation, we want you to feel confident in your financial future, so here are some ways you may consider prioritizing these goals depending on where you are in your financial journey.

Start with an emergency fund

We’ve said it before, and we’ll say it again. If you haven’t already, start putting money away in an emergency fund. Plan to save three to six months’ worth of expenses that you can tap in case you encounter an unexpected expense, lose your job, or are unable to work and need a little bit of time to get back on your feet. Create an emergency fund before paying off debt so that financial emergencies, such as a leaky roof or a medical issue, don’t send you into even more debt.

Pay down high-interest debt

Most people have some kind of debt, whether mortgage payments, student loans, or credit card debt. However, not all debt is created equal. Some debt is “good,” helping you build a more secure financial future. For example, a mortgage can help you build equity in a home.

Other debt, such as high-interest credit card debt, isn’t so helpful. Consider that credit card interest rates can be between 16%–25% depending on your credit score. If you don’t pay off your credit card bill in full each month, your debts will compound, growing increasingly larger every month. While compounding growth is great for your savings, it’s terrible for your debts. Paying credit cards off first can minimize or eliminate the amount you’re spending just to make interest payments.

When it comes to debts with lower interest rates, such as mortgages or student loans, weigh the value of paying them off sooner against accomplishing other financial goals. For example, putting extra money toward paying off a mortgage with a 4% interest rate may not be as beneficial as investing, if you believe you can generate a higher return on your investments.

Invest in your future

Once you’ve tackled the high interest rates that are working against you, you can start putting money toward investing to meet long-term financial goals, such as retirement. Start by funding a tax-advantaged retirement account, such as a 401(k) or IRA, which can supercharge your savings through tax-deferred potential growth. You fund each account with pre-tax dollars, and you pay no income tax on it until you make withdrawals after age 59.5.

If your employer offers a 401(k), aim to save at least enough to qualify for any matching funds they may offer, and max out your savings if you can. In 2021, employees can contribute up to $19,500 a year, or $26,000 if you’re 50 or older.

If your employer doesn’t offer a retirement account, or you want to save even more, consider opening a traditional IRA, which allows savings of up to $6,000 a year, or $7,000 for those age 50 and older. You may also consider a Roth IRA, which you can fund with after-tax dollars. The contribution limits are the same as for traditional IRAs, but money inside Roth accounts grows tax-free, and you pay no income tax when you withdraw it after age 59.5. Keep in mind, Roth IRAs do have income limits for who can contribute.

If you’re already maxing out your retirement accounts, or you want to save for pre-retirement goals, you may consider a high-yield savings account and/or a taxable brokerage account.

A taxable brokerage account allows you or your financial advisor to buy and sell a wide variety of investments, including stocks, bonds, and index funds. Any profit that you make from the sale of these investments is subject to short- or long-term capital gains taxes. You will pay short-term capital gains tax, which is equal to your income tax rate, on proceeds from investments held for one year or less before sale. Investments held for more than a year are subject to long-term capital gains tax, which is equal to 0%, 15%, or 20%, depending on your tax bracket. 

Save and invest regularly to ensure you can take advantage of compounding growth and are on a steady path toward reaching your financial goals. To make things easier, consider automating your investments and savings through payroll deduction into your 401(k) or by direct depositing a portion of your paychecks into your savings account.

Prioritizing your financial goals can help keep you get and stay on the right track. We are here to help you every step of the way as you tackle debt and build a secure financial future.

Check out our Savings Goal Calculator to see what it will take to reach your goals.

First Foundation Bank
About the Author
First Foundation Bank
First Foundation Bank serves individuals and businesses at all stages of their financial journeys. In addition to the usual deposit and lending offerings, trust services, wealth planning, investment management, and philanthropy services are all available to clients as part of the First Foundation Inc. integrated platform. Read more