Balancing Building Savings With Paying Off Debt (Podcast)

Thomas Walsh
Thanks for having me, Amy.

Amy Laburda
So starting out, since our podcast is about “something personal,” if you can think back to the first time you had a job where you were earning enough

00:34
to have more money than just the basics, to cover your necessities. Were you stoked about that? Were you like, “I'm a financial planner, I've got this, I'm so ready”? Or were you a little intimidated?

Thomas Walsh
You know, that's a great question, Amy. To be honest, it was a bit of both. As — being a financial professional, I understood the principles of budgeting and saving, but actually applying those principles to my personal life was a bit of a different experience. It can be a little overwhelming when you start to have these real

01:03
financial choices that go beyond just the basics. And there's definitely some trial and error, trying to find this, to balance this desire to enjoy my earnings with this need to save and invest for the future. So while I felt prepared in theory, in practice it was still a bit of a learning curve. And I will say I did well with sticking to the mantra to “pay yourself first.”

01:25
I didn't actually sit down and create a detailed budget like I probably should have. I knew it was important that I start saving and investing early. So I did regularly transfer extra cash to my investment account or make annual contributions to retirement accounts.

Amy Laburda
It's certainly one place I can say you had an edge on me. My first two working years, I'm like “401(k)? What's that?” Now I can easily look back and be like, “You had all that time, what were you doing?” But I think it sort of points to —

01:54
granted, I did not have your financial background — but I think it's easy to sort of look and see, oh, you know, I know what I should do, but like today I want to, you know, enjoy my life, do what I'm doing. And balancing that can sometimes be easier said than done, even if you understand the basics, I think.

Thomas Walsh
For sure.

Amy Laburda
So in our book, “The High Achiever’s Guide To Wealth,” you're the author of our chapter on saving versus spending versus repaying your debt. And it's really right up front.

02:19
We have a first chapter that's more sort of philosophically about what is wealth, what is achievement, which mirrors our earlier episode this season talking to our colleague Larry Elkin. But your chapter really is sort of the first deep dive into a more practical topic. That might seem a little basic to some of our readers, but why is getting the balance of saving, spending and repaying your debt right so important to starting off on the right foot?

Thomas Walsh
Well the reason it’s

02:46
so foundational is that these are a few of the core elements of personal finance, really. So balancing your spending with your saving and repaying debt, it's really how you build a sustainable financial life going forward. And it's not just a one-time decision either, because your circumstances, your goals, even your emotions are going to change over time. For example, your financial goals when you've just graduated college,

03:14
they might be focused on building an emergency fund or saving for a big trip. But once you're married and have kids, your priorities are going to shift to things like buying a home or saving for a child's education. So the trick really is just be flexible while maintaining discipline in these areas, because they really set the stage for everything else.

Amy Laburda
That makes a lot of sense. So listeners who've been listening along in order will have just heard our conversation with Rebecca Pavese, where we talked about budgeting in a little more detail. But

03:44
it seems like building a savings cushion and paying down debt, the sort of other two components of your chapter, can be complicated for a lot of people. Not only because, as you just said, goals change and you're in a different place, but starting out early in life, it can be emotional too, to sort of think about, “What kind of things are my priorities? What do I really care about? Am I willing to deny myself some of the things I want now in service of longer-term goals?” As a financial planner,

04:11
how do you deal with either clients or other people in your life asking you for advice who are struggling with this balance, either for practical reasons or emotional ones?

Thomas Walsh
Emotions definitely play a role in this, and that's completely natural. I've worked with clients who will feel overwhelmed by debt, or sitting down and putting together a budget, reviewing their expenses. But, you know,

04:35
one thing I tell them, and at least in the case of debt, is that… just to remember that debt isn't the enemy, rather lack of having a plan is. So making a plan really helps to separate the emotion from the decision-making process. And that often helps reduce stress. And that applies also to developing a strategy to repay debt. So I usually suggest starting with tasks that'll provide the client with some small wins, like setting a realistic budget or tackling a minor debt,

05:04
because it can start to build confidence and it helps shift their mindset from this idea that “I'm in a hole” to “I'm actually making some progress here.”

Amy Laburda
Yeah. So you've sold me, let's zoom in and start with a concrete plan a little bit. Obviously everyone is different. We say almost every episode that there's no one-size-fits-all goal. But say a younger person, early in their career, is sort of starting from scratch for the first time getting started with this kind of exercise.

05:31
How do you suggest people take a first step towards balancing their cash flow?

Thomas Walsh
Sure. I always recommend starting by looking at where your money is currently going. You can try to track your spending for a few months, or review your bank and credit card statements for maybe the last three months, and try to categorize those expenses and try to find areas where there's room for improvement.

05:55
If the thought of going through your expenses and documenting them in an Excel spreadsheet, if that sounds daunting to you, you should check if your bank offers some budgeting tools. I found that a lot of banks and credit card companies will actually categorize your spending for you. And that can make it a lot easier to get started. And then, once you know where your cash is going, you can work on starting to set some realistic goals. Once you do that, you can go ahead and start to think about, “Where can I cut

06:24
expenses? What areas is there room to do this?” And cut your spending where you can, especially on things like subscription services or larger discretionary spending that you could live without. These tend to have the biggest impact on your spending and your budget. And then if debt — if you find that debt is weighing you down, go ahead and prioritize paying that off while still setting aside some cash and savings, particularly for emergencies. You don't actually have to make drastic changes all at once,

06:54
but even just small adjustments can make a big difference over time.

Amy Laburda
Yeah, it sounds like those small wins you were talking about can start to add up if you're building good habits. It's that positive feedback loop early on that's so important. So I think in an ideal world, it's obvious to most people why it's better to make more than you spend in a month, in a year, in a given amount of time. But to sort of dive in a little bit deeper, why is building a savings habit specifically so important?

Thomas Walsh 07:23
Well, saving is really crucial because it helps provide financial security and it really helps give you peace of mind when you have a nice cushion of savings. Without savings, especially like an emergency fund, you're going to be forced to rely on this high-interest debt when unexpected expenses come up, like a medical bill or a car repair that you weren't expecting. With savings, you're

07:48
also going to be less likely to make rash decisions when under pressure. And it helps you avoid accumulating more debt to address those issues as they crop up. Beyond that, savings help you build toward larger goals, like buying a new home or funding education or even retiring comfortably. It's not just about putting money away for the sake of it. It's really about giving yourself that flexibility and stability to handle

08:15
life’s surprises and really be able to capitalize on life's opportunities that may arise.

Amy Laburda
I think we'll probably circle back to some of those long-term goals here shortly, but emergency funds have come up a couple of times already in our conversation. I think it's easy when you're starting out to sit down and think, “OK, these are my recurring expenses every month. This is my necessities. This is what I have to save. And this is what I can enjoy and that's fine.” And then things like you said:

08:43
you get in a fender bender, or you unexpectedly, like, sprain your ankle. And suddenly these new expenses come up. So when you're starting out and you're building that emergency fund to avoid taking on debt to deal with those unexpected expenses, how big should you generally make that savings cushion?

Thomas Walsh
That's a good question. And I really can't stress the importance of having an emergency fund enough. It's really just one of the building blocks here with saving. And

09:11
the size that you're going to want to have in an emergency fund is going to vary. A common rule of thumb is you want to aim for three to six months’ worth of living expenses. The exact amount is really going to depend on your personal situation. For example, if you're in a dual income household and, say, you have very stable employment, something like three months may be

09:36
more sufficient. But if you're the sole breadwinner or you have irregular income, because let's say you're self-employed or you're paid on commission, you're going to want to maintain closer to six months of expenses in an emergency fund. But ultimately, the right amount depends on a number of factors like your job security, your risk tolerance, and even simply just what makes you sleep better at night.

Amy Laburda
And, I imagine, whether people are relying on your income besides you.

10:03
A variety of factors like that, also in play for everyone. So once you have set aside money, or you're planning to start setting aside money, where should you actually put your emergency fund? Does it just live in your checking account? I imagine not. But where should it go instead?

Thomas Walsh
So you're going to want to keep your emergency fund somewhere that's liquid and has little to no risk of declining in value. You want it to be

10:29
easily accessible in case you need it. So I typically recommend keeping it in a savings or a money market account. That is typically going to be FDIC insured. You don't really want to hold it in your checking account, because you might be more tempted to spend it if it's in there. And you also don't want to have the funds tied up in investments that could make it much harder to access when you really need it in a pinch. Given the current interest rate environment, money market funds actually are offering

10:57
fairly attractive returns, with very minimal investment risk. And they're also highly liquid, meaning you have very quick access to your cash when you need it. The main thing you're going to want to think about is that the goal for your emergency fund isn't necessarily to earn a high return, rather it's to keep that money safe and available for when you really need it.

Amy Laburda
That makes sense. So we've emphasized, I think, hopefully enough, that an emergency fund should probably be one of your first savings priorities. And

11:27
obviously, if you withdraw some of that money to deal with an emergency, you're going to want to top it up. If your lifestyle changes, you're paying more rent, that kind of thing, what three to six months of expenses looks like can change. But I think once, say you've basically got your emergency fund, plus or minus some maintenance, squared away. Once that safety net is in place for you, how do you then start thinking about those longer term saving schools that we talked about?

Thomas Walsh
Sure. So once your emergency fund is in place,

11:57
the next steps are really going to depend on your personal goals. You know, are you… You want to think about: Are you trying to save for retirement? Or would you like to save for a down payment on a home? You know, are you a funding an education for yourself, or maybe a child? So really just think about your goals, be honest with yourself, and prioritize them based on what's most important to you. And the way you save can change too, depending on the goal. For instance, you know, if you're saving for retirement, you definitely

12:26
should consider saving in tax-advantaged accounts, like a 401(k) or an IRA. You know, there's other tax-advantaged accounts for other goals too, you know, like for saving for education in a Section 529 plan. But for your shorter term goals, you know, a regular savings account might be the most appropriate.

Amy Laburda
We aren't going to dive all the way into investments today. We have a separate episode on that last season, which I will commend to our listeners if they haven't heard it already. But just to touch on:

12:54
Why does time horizon make a difference in these savings goals? Why are you more inclined to put things for long-term in an investment account, versus something more stable for a short-term goal?

Thomas Walsh
So, for longer term goals like retirement, your investing does become much more important. Really, it's largely because of this thing called inflation. I know we're all very well aware of the effects of high inflation and what it does to prices, like we see when we go to the grocery store or fill our gas tank.

13:22
So in the same way that inflation causes prices to increase, it's also going to erode the value of your savings over time. Put it another way: If you, let's say if you stashed a $100 bill in your mattress five years ago, and you took it out to spend at the grocery store today. You're coming home with significantly fewer grocery bags than you would have back then. So that's an example of sort of how inflation takes away from your savings.

13:49
And essentially, your savings didn't grow at the same rate as inflation. And really, they didn't grow at all, while they were in the mattress. So how do you keep up with inflation? Historical data shows that the best opportunity you have to grow your savings, at least as much as inflation and potentially outpace it, is to keep your savings in riskier investments, like equities or stocks.

14:14
Ultimately, the amount of risk you actually take with investing your savings is going to depend on the time horizon for different goals. So generally, the longer the time frame, the more risk you can afford to take by investing your savings more aggressively. And I typically advise keeping savings that you plan to spend in the next five years, to be invested more conservative, like in fixed-income investments or things like bonds. Anything longer than that, and

14:43
you can typically start to consider investing in the stock market.

Amy Laburda
That sort of brings me a little bit with inflation and interest rates to pivot towards the more fraught part of the three parts in your chapter, which is debt repayment. I think we already touched on: Debt can be very emotional for a lot of people. But also it can just have a lot of practical downsides in your day-to-day financial life.

15:06
As of this recording, the Federal Reserve reported that Americans collectively owe more than $1.7 trillion in student loans alone, which is pretty staggering. And of course, that doesn't even touch on mortgages, auto loans, credit card debt, all of the other things that our listeners may have in their lives. So if you're someone who is carrying significant debt of one kind or another, should you really be prioritizing these long-term savings goals at all?

15:32
Or should everything that's not going to necessities just go towards paying down your debt as fast as you can?

Thomas Walsh
Yeah, it's a great question. And really, it is a balancing act. You definitely don't want to ignore savings completely, especially in regards to an emergency fund. But once you have that in place, how you then allocate your extra cash, it can start to depend on the type of debt that you have. For instance, high-interest debt, like credit card balances, those are going to take

16:01
priority, because those balances can snowball quickly. For your lower-interest debt, like federal student loans or mortgages, it can make more sense to pay them down while still contributing to your savings and not just solely prioritizing paying that debt off.

16:18
An example here would be if you have access, let's say, to a 401(k) that offers employer matching contributions, you're essentially receiving an immediate 100% return on the portion of your 401(k) contribution that qualifies for that employer match. So it really becomes hard to justify paying down that low-interest debt instead of making a contribution like that to your 401(k). In all instances, you're still going to want to make the minimum required payments

16:47
on your outstanding debt, so you can avoid any penalties. So this is more about balancing what you do with the extra cash that you have coming in.

Amy Laburda
As a financial adviser, I'm sure you deal with people who have a variety of levels of debt in their life, and who feel a variety of ways about it. Do you run into people who just get paralyzed, who feel like it's too big a problem? “I don't know what to do. I don't know how to even start chipping away at this.”

Thomas Walsh 17:13
For sure. Those feelings are pretty common and they definitely can be paralyzing. I always remind people dealing with this that debt really isn't a personal failing, or it's not a negative reflection on you and who you are. It's really just a financial tool. What really matters is how you manage it. If you feel stuck, the best thing you can do is to start with a plan. Sometimes just knowing what you owe and having a roadmap to

17:43
pay it down can really make the situation feel more manageable. Debt is just one part of your bigger financial picture, so you really don't want to let it consume you or stop you from planning for your future. It's kind of like the old analogy, how do you eat an elephant? You do it one bite at a time. You don't have to necessarily tackle everything at once. Just take small, manageable steps. Before you know it, you're making real progress.

Amy Laburda 18:10
So let's pick up our forks and approach the elephant. If someone is facing a large pile of debt, obviously there are going to be a variety of factors in play. But what are some basic steps to take first? You mentioned knowing what you owe. Is that sort of taking stock the first place you would advise people to start?

Thomas Walsh
You know, I would say the first step is to get organized. Go ahead and make a list of all your debts. Write down who you owe, how much, and the interest rate

18:39
associated with the debt. Then I typically recommend ranking them by the interest rate, and then focus on paying down the highest-interest debt first since compounding interest can really cause the balances on that debt to balloon very quickly. This category would typically include credit cards and credit card debt, which you want to get a handle on really before moving to other types of debt, such as student loans.

19:06
You should also prioritize paying down existing debt as much as possible before taking on any new debt. There are actually advantages to doing it this way, even if the debt isn't completely paid off, such as when you apply for a mortgage or an auto loan, the lender is often going to consider something called your debt-to-income ratio. They calculate this by taking your total monthly debt payments and they divide it by your monthly income.

19:36
So lenders like to use this to evaluate if you can responsibly take on more debt. Typically, if all your debt payments are less than about 36% of your income, you can reasonably take on more debt.

Amy Laburda
So a little bit of good news for people chipping away, that there are returns even before you finally get to debt zero, if that's your goal. So we've sorted by interest rate, and I think you've made pretty clear why that's important to do. But

20:04
I think a lot of people have heard, either in specific instances or just sort of vaguely in the air, the idea of “good debt” and “bad debt.” As a financial professional, what do you mean if those terms come up?

Thomas Walsh
Sure. So in a general sense, “good debt” refers to debt that helps you increase your net worth over time, like a mortgage or a student loan. These usually come with lower interest rates and they're considered investments in your future, really.

20:31
So “bad debt,” on the other hand, is generally your high-interest debt and debt that's used to fund nonessential purchases or discretionary spending, like taking on credit card debt or an auto loan that you use to purchase a fancy, high-end car or something. It's important to note that reality is a bit more nuanced than this, and your specific types of debt won't always fit neatly into either category. But it's a good reminder that not all types of debt are necessarily bad.

20:59
One example of what can sort of fit in either category would be student loan debt. You know, it could be good or bad debt, based on different factors, like: Is the loan federally subsidized or is it privately issued? Is it subject to an income-based repayment plan, which would place it more into a good debt category? You know, you can even go as far as asking yourself, “Did my education prepare me for a career that provides the flexibility to pay off this loan?” You know,

21:27
the key is really understanding how each type of debt impacts your financial situation, so that you can effectively prioritize paying it off.

Amy Laburda
I won't put you on the spot and ask you whether you think my student loans were a good idea or not, for a small liberal arts college in 2007, which was certainly an interesting time to take on as much debt as I took on for college. But I talked to our colleagues Brianna Aviles and Mamie Odom earlier this season about student loans. I won't make you deep dive into that too much.

21:56
But one thing we didn't really go into was consolidation and refinancing. I can admit it took me personally a few years to really understand the difference between those two things, and what my options were with them, back when I was in my 20s. So will you run our listeners through what consolidation and refinancing are, and why they're different from one another?

Thomas Walsh
Sure. You know, and I can see how that can be a little confusing. The two concepts are actually different though. You know, generally loan consolidation

22:24
simplifies payments, while refinancing is more about lowering your interest rate. With consolidation, you're combining multiple loans into one, which simplifies your payments by giving you just one bill to pay each month. For federal loans, it won't lower your interest rate. It really, it just gives you a fixed rate based on the average of the current rates you're paying. The downside is that it often extends the repayment period

22:50
on the loans, meaning you might end up paying more in interest over time. But if you have both federal and private loans, it's usually best to consolidate them separately, because you can actually lose the federal benefits like deferred repayment if you combine your federal with private loans. Refinancing, on the other hand, replaces your existing loans with an entirely new one at hopefully a lower interest rate, which can save you money in the long run.

23:17
The catch here is that refinancing is generally only available through private lenders. So you'll want to compare rates, make sure you're getting the best deal. And I'll also mention that it's not just student loans that can be consolidated or refinanced. You can do this with other types of debt as well, in certain circumstances.

Amy Laburda
I will note that I've been hard on my past self, but those mistakes also were not life-ending, and I did pay off my student loans eventually. So if you didn't get it right the first time, I'm here to say

23:47
there's hope to get it right down the line too. So don't feel like this episode is only for people who are just starting out. But stepping back from student loans specifically to just debt more generally, say someone has taken our first steps. They understand who they owe money to, they understand how much they owe, what the interest rates are, they've sort of gotten their ducks in a row. They're ready to start making a repayment plan above and beyond the minimum that they owe every month. How do you then approach,

24:15
beyond just your minimum payments, where does the money go?

Thomas Walsh
Sure. From here, it really is about putting together a repayment strategy. This is something you can do yourself. I'll just say, it's not uncommon for people to turn to a financial adviser for help with this part of the process. There are two popular repayment methods that I like to review with clients. They're known as the debt avalanche and the debt snowball methods.

24:42
The debt avalanche method, it involves ordering your debts by interest rate from the highest interest rate to the lowest. You'll then focus on paying off the debt with the highest interest rate first, while continuing to make the minimum payments on all of your other debts. Once you've paid that first debt off, you should still set aside funds for the minimum payment that was associated with that debt. That way you take that payment that was earmarked for the minimum payment, and then you apply that toward

25:11
paying the next debt on your list. And the debt snowball is the other method. And that one prioritizes debt based on the outstanding balance of the debt. So you prioritize the debt with the smallest balance first. And the reason you do that is that it tends to give you a psychological boost when you get it paid off. And it helps build that momentum toward paying off the remaining types of debt that you have.

25:38
You know, both of these strategies can be pretty effective. So it really depends on what's going to motivate you more. You know, is it saving money on interest over the long term, or is it gaining that… those psychological wins by knocking out your debts? So both approaches work. You should just choose the one that really motivates you more to paying off that debt.

Amy Laburda
So I think if you're someone with perfectionistic tendencies, it can be easier to sit down and say, “Well, which one is better?”

26:05
But it sounds like what you're saying is that neither one is better. It's about knowing what you will actually stick to and what actually suits your own psychology.

Thomas Walsh
That's exactly what it is. You want to find what's going to work for you. Either one can be appropriate. It's just what's going to get you to pay off that debt and stick to that repayment strategy. It doesn't… You may pay less interest with the debt avalanche, but if you're going to stop after

26:33
paying off a debt or two because it just feels insurmountable, or it's taking a really long time to pay off that first debt, you might give up or something. So it's really about knowing yourself and really just determining what's going to get you to stick to that strategy. On the other hand, the debt snowball, that proves to work just as well. It's just as effective and really helps with the psychological aspect

26:59
of, “Hey, I've paid off. This isn't as bad as I thought it would be. I'm knocking these debts out.”

Amy Laburda
Absolutely. So both the debt avalanche and debt snowball really sort of look at loan balances and interest rates in some combination, one more than the other in the different plans. But other than those two things, are there other factors, when you're sitting down to make a plan with a client, that can affect the order or the priorities when you're paying off debts?

Thomas Walsh
Yeah, definitely. You know,

27:28
you should always make at least the minimum payments to avoid penalties or damage your credit score. Also there's certain debts too, like back taxes, that should always take priority because they come with very serious consequences if they're left unpaid. It's also worth checking if any of your loans have something like early repayment penalties, although those are becoming less common, particularly with student loans. You want

27:56
to just be aware of specific terms of your debt. And if you have any debts that come with tax benefits, like mortgage interest or student loan interest, which you can receive tax deductions for, you'll want to factor those aspects into your plan too.

Amy Laburda
So say you're really struggling. Even — you have a plan, you're doing your best, but it's just really getting away from you, either because of high interest rates or other factors. Are there any other options, if you're having a really hard time with your debt?

Thomas Walsh
Sure. If you’re in a tough spot,

28:26
it's worth trying to reach out to your creditors directly. They may be willing to work with you to help restructure a payment plan, or a repayment plan, or even lower your interest rate, especially if you're at risk of default. So some lenders, they'd rather get paid a lower amount than not get paid at all. So those are real options. And there's also other options, like debt consolidation or working with a credit

28:54
counseling service. It really just depends on your situation.

Amy Laburda
So on the other side of the coin, the more positive one: Someone makes it through. They've done their whole plan. They're debt-free. They have a little party, or at least that's what I did when I paid off my student loans. Once you're debt-free, should you avoid taking on any new debt forever? I think earlier in the episode, you described debt as a financial tool.

29:17
But how does someone differentiate between the sort of debt that can further their financial goals and the sort of debt that gets them a little more behind the eight ball, as far as their finances goes?

Thomas Walsh
Sure. So like you said, debt, it can still be a useful tool. So you don't want to rule it out completely once you're debt-free. It's really about knowing yourself and understanding why you were in debt in the first place. If it was due to poor spending habits, you might need to be more cautious going forward.

29:48
But if the debt was tied to something like a home purchase or education, you know, these good types of debt, as they say, you know, taking on debt for similar reasons in the future could still be beneficial. The important thing is to really be mindful and intentional about how and why you take on debt, and then avoid falling back into old habits that, you know, might have put you into that hole in the first place.

Amy Laburda
So at the end of every episode, I make it a habit

30:15
to ask: Is there anything about today's topic we didn't touch on, either about saving habits, debt, something else, some other thing you'd like to include before we wrap up today?

Thomas Walsh
You know, I think we've covered quite a bit of ground. I guess if I were to add one final thought, it's, you know, that balancing spending and saving and debt repayment is really a process.

30:37
It's not about being perfect. It's more about staying consistent and being willing to adjust your approach as your circumstances change, which they are sure to do. And so having a plan is key, but remaining flexible and kind to yourself really along the way is just as important.

Amy Laburda
I think that makes perfect sense, and sometimes a hard thing to remember, but also one that I think, in the end, will help you have the resilience to step up and try again

31:04
as you need to make adjustments going forward. Thomas, thank you so much for talking to me today. It was a conversation that I hope a lot of our listeners will find really, truly useful.

Thomas Walsh
Thanks, Amy. I enjoyed it, and I hope our listeners can take something away from it that's useful.

Amy Laburda 31:21
“Something Personal” is a production of Palisades Hudson Financial Group, a financial planning and investment firm headquartered in South Florida. Our other offices are in Atlanta; Austin; the Portland, Oregon metropolitan area; and the New York City metro area. “Something Personal” is hosted by me, Amy Laburda. Our producers are Ali Elkin and Joseph Ranghelli. Joseph Ranghelli is also our director, editor and mixer. Our firm has written two books:

31:51
Looking Ahead: Life, Family, Wealth and Business After 55 and The High Achiever's Guide to Wealth, which offers advice for younger professionals, entrepreneurs, athletes and performers. Both books are available on Amazon, in paperback and as e-books.