As a rule of thumb, I always say that having an emergency savings with three months of expenses (at least) can protect you from relying on credit during a financial bind. But, I understand that in many cases, it’s hard to grow that fund. So, it makes sense that many clients ask me if they should still try and save or if they should just focus on paying their debt.
The answer to this question depends on the interest rate you are paying on your debt and the expected rate of return you might be able to earn on your savings/investments.
For example, if you have could choose between the following two investments which would you choose?
INVESTMENT A: Guaranteed rate of return of 19%
INVESTMENT B: Non-guaranteed rate of return of 10%
In this scenario you would obviously choose INVESTMENT A. It has a higher rate of return and the return is guaranteed. Assuming that an average credit card charges you a guaranteed interest rate of 19%, by paying-off your credit card debt you are choosing “INVESTMENT A”.
When I explain this situation to people I use the old saying “a penny saved is a penny earned”. What I mean by that is if you “invest your money” in paying-off debt you are saving high interest charges. These savings are the same as if you had earned interest at the same rate (leaving out tax considerations). Therefore unless you can find a guaranteed investment that pays more than 19% I would definitely recommend paying-off your credit card debt instead of trying to build up savings.
You should use our debt options calculator to see how much it might cost you to pay your creditors directly over the next five years. Keeping this amount in mind, it may be wise to review your situation with a licensed insolvency trustee. You may find that by filing a consumer proposal you are able to deal with your creditors and build an emergency fund.
If you are going to try to dig yourself out of debt on your own it is important that you have a plan. I would recommend reviewing your situation with a professional. I would be happy to meet with you personally and review your situation or you may want to speak with one of our partner credit counselling agencies. These credit counselling agencies are all not for profit and will be able to help to make sure you are on the right track.
