How-to-save-money-and-pay-off-debt-effectively

How to save money and pay-off debt effectively

Savings and its importance:

Healthcare, college tuition, and several emergencies cost a fortune, and those who have no savings need to borrow money in order to fulfill these needs. Having sufficient savings helps countless people sleep soundly, and without guilt. It reduces stress, as the saver has confidence that they can combat any financial emergency that comes in their way. Savings also help employees switch their jobs smoothly, without worrying about regular paychecks. It helps them choose different career paths and it can even help them start a business.

Being frugal has helped millions afford down payments and provide for emergencies. However, saving isn’t as easy as it sounds. Teachers, firefighters and laborers struggle with low wages, and find it nearly impossible to save up for a new home, or provide for healthcare. Strategy is everything, and even a simple one can change lives.

Distinguish between wants and needs:

Before introducing the savings rule, you have to distinguish between wants and needs. In simple words, needs are the basic necessities required to live a decent lifestyle. Getting a new pair of shoes, or a flat screen tv is far from a requirement. Most middle-class citizens spend a significant chunk of their paychecks on wants. In fact, consumer spending accounts for almost 70% of the US economy.

So, unlike wants, which only cause a minor inconvenience, needs are necessities like food, water, shelter and sanitation. A lot of people, especially in the US and Singapore, have such busy lifestyles that they can’t find time to cook. Even some college students do the same, and this not only compromises their health, but also puts a significant dent in their wallets. Similarly, hobbies that make you happy and provide a reason to socialize, also classify as wants. This includes flying drones, playing sports, painting and much more. Therefore, while saving, it is crucial to distinguish between wants and needs.

50% of your earnings should be used for needs, 30% for wants and the other 20% for savings.

50%: From regular expenses such as groceries, housing (mortgage or rent), healthcare and other needs that are crucial for your existence in society. Keep in mind that compromising on needs may impact health, hygiene and financial security. 

30%: Includes shopping for premium products and services, dining out and hobbies. Remember that wants are not necessary for living, but they improve lifestyle and bring happiness. Wants such as clothing also provide respect and a sense of self-worth, so never over-compromise on needs. This is exactly why 30% is such a sweet spot for your wants.

20%: These savings can not only be kept in the bank, but also be used for small emergencies and debt payment. Credit cards, student loans, emergency funds, and even regular investing should be done with 20% of your monthly income.

Managing debt:

Paying off debt has become a major problem for most people. At this day and age, not only adults but even students are trapped into tremendous debt. Unfortunately, only a few of them know how to manage their debt and pay it off successfully. Essentially, there are two classic strategies used for paying off debt:

Debt snowball method:

This method dictates that you must pay-off the smallest loan balance you have first, regardless of interest changed. I know this sounds absurd, but the reason is that as you start paying small amounts of debt, you may get a psychological boost that you’re getting results. If you’re worried about interest piling up on you, ramseysolutions.com has provided an excellent reason for sticking to this method:  

Now, before you start arguing about the interest rates, hear us out. If your largest debt has the largest interest rate, it’s going to be a long time before you start to see a dent in that crazy balance of yours. But when you stick to the plan (without worrying about interest rates), you’re going to be jumping up and down when you pay off that smallest debt super quick. That excitement is what’s going to motivate you to keep working hard—all the way to that debt-free finish line.

Along with its psychological advantage, there is a downside to this method as well.  If you start following the method now, the existing high interest debt that is due soon, will be left unpaid. This will lead to penalties, and low credit scores.

Avalanche method:

According to this method, you should pay off the debt which has the highest interest rate attached to it. This reduces stress and it can help avoid interest if paid before the grace period. The avalanche method is especially useful to pay off good debt, like student loans, business and any other loans that will contribute to future income.

Good debts need to be prioritized, because of high interest and the sheer size of the loan itself. It obviously cannot be paid off in one go, however, paying a fraction of it each month will keep your head well above water.

Conclusion:

Along with paying off debt and saving for future emergencies, spend some money to educate yourself financially by buying books and exercising your brain.

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