day in the life: lunch money

Debt somehow seems to be synonymous with life in the developed world. Almost everyone has it and almost everyone suffers because of it. Much like alcoholism, people have a moment of clarity when people decide it’s time to change and start paying down their debt. Once their debt is paid off, they can then put that money into an RRSP or what-have-you.

Ultimately, you want to be in a position where you can start building up an equity, so you can retire. The debate has been out for ages as to whether it’s better to pay down your debt and then save, or to do both at the same time. For the most part, the most intuitive plan of action is to focus on paying your debt down, because of that yucky feeling that comes with the word “debt.” To settle this once and for all (at least for the people who read this), I thought it’d be fun to do a few illustrations to show which scenario would actually come out on top.

Let’s Make a Few Assumptions

Let’s set the scene. Our friend, Mr. Crazy Spender, has built up credit card debt of $10,000 at 20% interest. He makes average money, but after paying rent and such, he has $400 to spend on paying the credit card down.

Paying Down the Debt First

Paying $400 a month, your debt of $10,000 will be paid down in 33 months. Once that’s paid down, that $400 can go straight into an RRSP with an 8% rate of return. In 7 years of this, you’ll have built up a capital of $27,867.

Saving and Paying the Debt at the Same Time

Let’s assume that you’ve been persuaded by a financial advisor to do what seems really counter-intuitive and not to focus on paying down the debt, but to pay it down at the same time as saving money. Putting $350 to pay down the debt, it’ll be completely paid off in 40 months. During this time, putting $50 a month into an RRSP from day one for those 4 years, and $400 a month in the last 6, at an 8% rate of return, you end up with a capital of $29,160.

So What’s Your Take?

It’s not as obvious as most would’ve thought. However when you look at investing, the a little bit of money with more time will always win over more money with less time. Like any financial strategy, it all comes down to what’s important to you.

If you can’t shake that feeling of debt, then by all means pay it down. If you want the security of having liquidity in the event of an emergency, then do a bit of both. In any case, the ultimate goal is to get you into a financial position to break free from the shackles of debt.

Aaron Koo is a passionate networker and entrepreneur who gets people out of that “someday” mentality about understanding their finances.