Budgeting

Is it Better to Grow Your Savings or Eliminate Debt? Here’s How To Avoid Making a Big Mistake

is it better to save or pay off debts

Jeff Cuellar

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Should you use your available cash to grow your savings or eliminate your debt? That’s a tough question that many Singaporeans struggle to answer each month. It’s a tough decision to make because both choices are good for your financial well-being.

However, the real answer to this tough question is… it depends. It depends on your financial situation – that means your obligations (debt, loans, etc.), priorities (buying a home, retirement, etc.) and income (fixed, variable, etc.).

Here are a couple of important factors you should consider before deciding where to park your spare cash each month:

 

Do You Have an Emergency Fund to Begin With?

This is a major financial priority that every Singaporean should work towards fulfilling. Building an emergency fund should come before saving or investing for retirement.

However, if you’ve built up quite a bit of debt, especially credit card debt, you should work to pay that off first. If you don’t have an emergency fund, you can use one of your paid-off credit cards as a temporary “emergency” fund while you pay off the rest. Building additional revenue streams (see below) will make it easier to accomplish both at the same time.

If you don’t have any “emergency” cash set aside to cover you in the event of an unforeseen emergency (ex. retrenchment, car accident, injury, etc.), you’re setting yourself up for financial disaster.

The last thing you want to do is resort to your friendly neighbourhood “Ah Long” for emergency cash.

So how much should you save up? At the very least, start out with $1,000 and work your way up gradually towards saving up an amount equal to 3 to 6 months’ of expenses at the very least if you have a steady income.

If you’re making a variable income, you should be saving up more than that – as much as 7 to 8 months’ of expenses. That’s because there’s no way to predict when you’ll have bad months or how long such “low-income” periods will last.

Keep in mind that your emergency fun is NOT your savings – it’s to be used for financial emergencies only.

 

Look at the Interest Rate When Deciding on Saving vs. Paying Off Debt

Deciding on whether to pay off debt or saving depends heavily on one factor – the interest rate. If the interest rate to pay off a debt is higher than the interest rate while saveing – always put your extra cash into the higher of the two (ex. you have $500 extra cash each month and you put decide to invest it because you can earn 8% interest while the interest on your car loan is only 2.88%).

Now let’s say you have a $5,000 loan to pay off and the interest rate is 7.5%, should you put your extra money into paying it off, place the money in a savings account or invest it?

Considering that you’re likely to save more money on interest by paying off the debt than investing any available cash you have – it’s probably better to pay off the debt first. That is unless you’re an expert, high-risk investor who can earn 12%+ on investing that same amount of cash.

As for placing your spare cash in savings, well, it’s good to have some of your investment portfolio in “cash” because you need some cash reserves. But if you’re only making 1%+/- interest in a savings account, it’s really not worth it.

Credit card debt on the other hand is VERY dangerous, due to the high interest rates associated with them (18%+). In most cases, eliminating this debt as quickly as possible will be your priority when it comes to the question of saving vs. paying off debt.

 

Generating Additional Income Will Help You Save AND Pay Off Debt

Growing your savings and paying off your debt isn’t easy. It’ll take plenty of hard work and patience to accomplish both. But if you’re willing to put in some a little extra work, you’ll be able to reach your financial goals a little quicker.

Here are some common ways Singaporeans generate additional income:

  • Freelance Work: If you have skills that can be “sold” to other businesses, such as design, translation, writing, programming, photography, etc., market yourself on freelance websites or classifieds to earn extra income.
  • Become a Tutor: If you’re particularly good at playing an instrument, using a complex software program, speaking a foreign language, or certain tough academic subjects (maths, science), tutoring could yield some good income.
  • Sell Your Old Crap: If your storeroom looks like the attic from the movie The Goonies because you’ve hoarded tons of antique junk and trinkets, you should try selling anything without too much sentimental value. Who knows? Maybe you’ll find a treasure map in there somewhere!
  • Rent Out Your Spare Room: If you’ve got enough room in your flat to take on a new tenant, it’s worth exploring this option. You can easily earn another $700-$1,000+ per month this way. Just make sure you’re screening your tenants before you rent out (read this to find out more).

If you’re willing to work a little harder to build up those extra revenue streams, you’ll find that building up your savings and paying down debt becomes much easier!

What factors did you consider when deciding on whether to pay down debt or build your savings? Share your thoughts with us on Facebook! For even more useful information on everything personal finance, visit MoneySmart today!

 

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Jeff Cuellar

I'm known by many titles: copywriter, published author, literary connoisseur, ex- U.S. Army intelligence analyst, and Champion of Capua.