Money management can be a tricky subject. Everyone’s situation is unique, but
there are a lot of situations that are similar and can often be an issue of
debate on how best to handle them.
For instance, let’s say that someone has $50,000 in savings
in a bank account (with no other significant savings and assets) and also has
$50,000 in student loan debt.
Should the person use the savings to pay off the student loan debt?
From a numbers standpoint, it is far better to pay off the
debt, assuming that the interest rate is higher than what the money would be
earning in the bank. At today’s
rates, it would be safe to assume that the interest rate on the debt will be
higher.
The problem here is the uncertainty of the future. Let’s say the person lost his job and
could not find other work right away.
He would need an emergency fund.
So in that situation, he would be better off with $50,000 in the bank
and student loan debt.
If he had used up all of his savings to pay off the debt, he
wouldn’t have any cushion. He
might end up using credit cards, ultimately making his situation possibly worse
than having the original student loan debt. Or worse, he might end up living in virtual poverty until
finding a new job.
Of course, if the person had a low paying job and had very
low living expenses, then maybe using a good portion of the $50,000 to pay off
the debt would be a good idea. The
person figures that if he loses his job, he can probably find another one quickly
due to the already low wages. Or
maybe he lives with family and knows that he would not be out on the street if
he lost his job.
Again, this just shows that each situation really is unique.
Another interesting scenario is if someone has an
employer-sponsored 401k plan and also has credit card debt or student loan
debt.
Let’s say that someone has $20,000 in credit card debt and
has to choose on whether to contribute to his 401k plan. If he contributes, he will get a 5%
match from his company.
While some people see the 5% as free money that should not
be turned away, it is also hard to argue with the concept of getting rid of
credit card debt first. If the
person can only make the minimum payments on the debt, then perhaps he is
better off not contributing to the 401k for a while and getting the debt paid
off, assuming he is disciplined enough to do so.
If you put money into a 401k, you are really locking up your
money. You can’t really access it
in most cases. If you lose your
job, you could take a withdrawal, but then you would pay taxes and a penalty on
top of it.
It is also important to acknowledge that there is an
emotional aspect about money management.
It is not all numbers. Most
people will gain great satisfaction from paying off their credit card
debt. It is like new found freedom
when it finally happens. And
having credit card debt can be a great burden and cause some people a lot of
emotional stress.
Even if contributing to a 401k is better in terms of the
numbers, it might be worth the emotional benefit of getting rid of the credit
card debt.
So while there isn’t always a right answer to certain
questions about money management, the right answer often lies in the emotional
well being of the person. Every
situation is unique and every person’s attitude and personality are different.
If you are ever having trouble making a financial decision,
figure out which one will help you sleep the best at night. In most cases (not all), that will be
the best decision.