Debt or Savings: Which Should You Attack First for a Financial Breakthrough

When it comes to achieving a financial breakthrough, the question of whether to attack debt or savings first is often debated. The conventional wisdom suggests paying off high-interest debt first, while others argue that building an emergency fund should be the priority.

Let’s take a closer look at the math and mechanics behind this decision. When we’re dealing with debt, we’re not just paying interest on our principal balance – we’re also paying for the privilege of borrowing from banks in the first place. These costs are hidden fees, often referred to as “opportunity costs” that can add up quickly.

For example, let’s say you have a credit card with an APR of 18% and a balance of $10,000. Each month, you’re not only paying off the principal amount, but also $1,800 in interest charges. That’s right – almost twice what you’d pay on a credit card with a 0% introductory APR.

Now, when it comes to savings, we’re often told that having an emergency fund is essential. But let’s be real – who needs an emergency fund if they can just build up enough capital to cover their living expenses? The answer lies in the mechanics of compounding interest.

When you put your money into a savings account, you’re earning interest on your deposits. This may not seem like a lot, but it can add up over time. For example, let’s say you deposit $1,000 into a high-yield savings account with a 2% APY. After one year, you’ll have earned approximately $20 in interest – that’s a 100% return on your initial investment.

Now, here’s where it gets interesting. When you’re paying off debt, you’re not just reducing the principal balance – you’re also redeploying funds from high-interest accounts to lower-interest ones. This is known as “rate decay” and it can be a powerful tool in achieving financial freedom.

For example, let’s say you have two credit cards with balances of $5,000 and $3,000, both carrying 18% APRs. If you pay off the smaller balance first, you’ll not only reduce your total debt burden, but also redeploy more funds to the higher-balance card. This can help accelerate the payoff process and save you thousands of dollars in interest charges over time.

So, which should you attack first – debt or savings? The answer is both. By understanding the hidden mechanics behind these financial concepts, we can create a strategy that not only attacks high-interest debt but also redeploys funds to build up our savings accounts.

Here’s an example of how this might play out:

Let’s say you have a credit card with a balance of $10,000 and an APR of 18%. You’ve decided to pay off the principal amount aggressively, while also redeploying any excess funds towards your savings account. After one year, you’ll have paid off approximately $5,000 in interest charges – that’s a 50% reduction in your total debt burden.

At the same time, you’ll have deposited approximately $2,000 into your high-yield savings account, earning approximately $40 in interest over the course of the year. That may not seem like a lot, but it’s a significant step towards achieving financial freedom.

The key is to understand that this strategy isn’t about “budgeting harder” or “cutting expenses.” It’s about using the hidden mechanics of compound interest and rate decay to our advantage. By attacking both debt and savings simultaneously, we can create a powerful financial engine that drives us towards our goals faster than ever before.

So, don’t be fooled by the conventional wisdom – it’s time to think outside the box and use your money against itself. With the right strategy, you can cut your payoff time in half and achieve financial freedom sooner rather than later.