How to spend extra money smartly

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Dear Debt Adviser,
My question is where to focus any extra monthly income? Originally we wanted to throw everything at our credit cards so that we could eliminate our high credit card debt, improve our credit and, as a result, be able to refinance our house and car at a lower interest rate.

Now with the economy doing so badly and the jobs’ futures up in the air, I’m at a complete loss. Should I keep putting all our extra money on our credit cards or stash it all into savings in case the worst happens?! Right now, we only have $1,000 in savings which is obviously deficient. But we really wanted to get our credit cards paid off. Help! What should we do?
— Gwen

Dear Gwen,
You are being way too hard on yourself. After 18 years in the business of helping people navigate turbulent financial waters, I am still optimistic that when people are given the basic tools of personal finance, they can and do work wonders. To start, you are doing better than you think. You spend less than you earn, for one thing. You have savings, not enough, but you have some, and starting to save is often the hardest part. Most importantly, you want to provide for an uncertain future not just fund the present. All you lack is that basic tool, and I’m glad to provide it.

I would recommend that you strike a balance between setting aside money in an emergency savings account and paying down your debt. How to do it? Easy, the tool you need is called a spending plan or a budget. Here’s an overview and a suggestion.

Begin by setting a few goals. Surviving a layoff is a good one and so is paying down your debt. But, include positive goals like saving for a vacation, car, house or education. Avoiding a negative event works as a goal, but not as well as working toward a positive goal. In my book, financial goals are an essential but often overlooked part of budgeting.

Next, develop a spending plan that allows for living expenses, saving and credit building. Write down all your living expenses until you account for at least 90 percent of your take-home pay. Include savings for goals in this number. The less secure you think your jobs are, the more money you want to devote to your reserve fund until it gets to six months of bare-bones living expenses.

As for the credit card debt, the key is to stop charging. Using cash, checks or a debit card will give you a better feel for what you are spending than you would by using credit. To figure out how long it will take you to pay down your debt, start by using the calculators and creating several different scenarios with your credit card balances.

For example, determine how long it would take you to pay off your balances paying the minimum due, $100 more than the minimum and $200 more than the minimum. In addition to the time it takes to pay the balances, pay attention to the amount of interest you will pay in the different scenarios. The information will help you decide how to best balance your spending, saving and debt repayment. You may be willing to take a little longer to pay down the debt if your interest costs are not outrageous and use some of your extra income in other ways.

I think you are very smart to be thinking about worst case financial scenarios. The job markets are extremely volatile right now, with people losing jobs who would not have believed their jobs would be in jeopardy. You are ahead of the game already and with a spending plan and some goals, you’ll be on very solid ground with your finances.

Good luck!

Read more Debt Adviser columns and more stories about debt management.

The Debt Adviser, Steve Bucci, is the president of Money Management International Financial Education Foundation and the author of “Credit Repair Kit for Dummies.” To ask a question of the Debt Adviser go to the “Ask the Experts” page.