Color of Money: Don't keep debt around like it's a Pet Rock
-- Don't ignore the need to have some emergency funds. Life happens, and when it does, the last thing you want to do is rack up new debt while you're trying to get out of old debt.
How much you should keep in your rainy-day fund depends on the answer to at least one key question: Do you have a stable employment situation? For instance, if you've heard rumblings of layoffs, don't deplete your cash savings to aggressively pay off liabilities in case you end up losing your job. Cash is king in such situations.
But if your employment is as secure as it can be these days, don't park a huge amount of money in a savings account paying 1% interest when you have credit-card debt with a double-digit interest rate. So if $20,000 is all the cash that this couple has, I would advise them to hold back about $5,000 -- or maybe one month's worth of living expenses -- and use the rest of the money to hack away at the student loans.
Ultimately, the goal should be to accumulate, if you can, three to six months' worth of living expenses. But that's a target you should aim for after you've gotten rid of consumer debt (excluding a mortgage).
-- Don't touch any retirement savings. If you take money out from your 401(k) account or IRA before you turn 59 1/2, you incur a 10% early-withdrawal penalty, in addition to having to pay income tax on the distribution.
-- Don't worry about falling behind in retirement savings -- yet. The younger you start saving for retirement, the better. But most people retire in their 60s, so this couple probably still has three decades to save for retirement. Plus, once the debt is gone, they can take the money they were using to pay down the student loans to catch up on their retirement savings.
I know some will say -- if the student loans are at a low-interest -- that it's better to invest and keep making the scheduled payments. I would argue that's Pet Rock thinking.
If you have the means to be free of debt, don't keep it around like it's a pet, or it could end up weighing you down more like a boulder.
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