Debt might be a good reason not to save
A recent study by Royal Bank is showing that Canadians are having tough time saving money. Over the past 2 years
- 46% of people have stopped or reduced savings
- only 12% have increased savings
- 38% of people are not saving money
- only 33% are saving regularly.
- 55% of Canadians find it is hard to be disciplined to a savings habit.
Although these statistics might be alarming, should we really be surprised? We live in a society that values consumption. For the past 20 years the solution to economic slowdown was to encourage spending. Spending is the opposite of savings. They are like two heavyweight champs battling it out for the belt and unfortunately, spending is winning the battle.
If you think about it, spending is more natural. Its more fun. It’s kind of like a drug in that spending makes us feel rich. Ironically, the only way to get rich is to save more money and not spend it!
Should people really be saving more money?
The obvious answer to this question appears be yes but having lots of debt might be a reason why you should not be saving money. It’s likely that there is greater benefit in paying down debt before you start saving.
Recently I met with a single mother named Jackie who is raising 2 children on her own. She has accumulated about $20,000 of debt on her personal line of credit and is really stressed about it.
If you think about it, It makes no sense having money in savings earning 1% or less when you have debt costing you 5% or more. Every day you have this scenario, you are going backwards financially. Paying down debts might be the best form of savings and investing.
Paying down debt can be one of the best investments you make
My suggestion to Jackie was to take the TFSA and put it right against the line of credit. My justification for this was simple. Everyday she has this savings and TFSA making about 1.5% she is losing money. She is losing money because her line of credit is costing her 5%. Holding both the savings and the debt at the same time guarantees a profit for the bank and a losing strategy for her money.
If you want to get technical about it, the debt is actually costing her more than 5% on a pre-tax basis. In order to pay down a dollar of interest, on the line of credit, Jackie must make more than a dollar at work because she has to pay tax. In other words, she earn $1.47 to net one dollar after tax.
By using the $10,000 towards debt, she will save $41.67 per month in interest. Keeping the TFSA makes her much $12.50 per month which is much less than the $58 monthly cost.
But what happens in case of an emergency?
Jackie understood the math, but still expressed the concern that she would not have any savings or emergency money.
It’s important to remember that Jackie has less debt and can use her line of credit as the emergency fund. This strategy only works if you have the discipline to not run up the line of credit again.
The bottom line
Jackie’s situation is a perfect example where saving money does not make sense because there is a bigger bang for her buck in paying down debts. I think we forgot somewhere along the line that paying off debts can be one of the easiest and smartest investments we can make. Instead, debt has become big business and financial institutions are quick to encourage more debt as opposed to get out of debt.