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Columns: Dr. Don
Don Taylor, Ph.D., CFA, CFP   Expert: Don Taylor, Ph.D., CFA, CFP
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Flexibility vital to good savings plan
Ask Dr. Don

Don't mortgage present to fund future
 

Dear Dr. Don,
I am 22 years old. I just landed my first job out of college. My monthly income will be about $2,250 a month, or $27,000 a year. I have $4,000 in credit card debt and $26,000 in student loans. All have reasonable interest rates.

When should I begin to save money? Should I pay off all credit card debt first and then start to save? I understand that it is not practical to try to save money while servicing debt. Interest earned and paid cancels each other out, right? Help!
-- Motivated Maya

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Dear Maya,
Congratulations on the new job. Your conflict in choosing between saving and paying down loans is a common one for people just starting out in their career.

Interest paid and interest earned seldom cancel each other out, because interest paid isn't tax deductible (with some exceptions -- like student loan interest or home mortgage interest) but interest income is almost always taxable income. Earning 3 percent after-tax on a money market account doesn't quite stack up against paying 13.42 percent on a credit card.

Even so, I can't recommend that you put all your efforts toward paying down the debt. You need to build a measure of financial flexibility, and it's saving or investing that gives you such flexibility, not paying off a credit card or student loan balance. Strike a balance between the two.

If you can use the student loan interest expense as a deduction on your income taxes, the effective rate on that loan is lower than the nominal, or stated, rate on the loan. That should mean that you work on paying down your credit card balances first.

On the savings side, if your company offers a 401(k) plan and matches all or part of your contributions, at least part of your savings should go toward that plan. I'd normally suggest contributing up to the limits of the company match, but that may not be practical on your monthly budget. In addition, it won't help build financial flexibility if you don't have ready access to those funds in a financial emergency.

Building a cash cushion provides a measure of liquidity to keep you from living paycheck to paycheck and can also help keep your credit card balances lower.

Bankrate.com's corrections policy -- Posted: Dec. 5, 2007
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