Debt Reduction: Penny Wise and Pound Foolish
Today I’m going to start off by asking a couple of questions…
Are you carrying any high interest debt?
Do you have any money in the bank?
If you answered yes to both of these questions, then let me ask another one…
Just how much money do you have in the bank?
The reason I ask is that a surprising number of people are holding excess cash in the bank while paying ridiculous interest rates and failing to get out of debt.
Sure, you need an emergency fund — and you might want one that’s somewhat larger one than normal given the current economy — but you’re making a mistake if you’re sitting on more cash than you really need.
On the one hand, this is a good problem to have. After all, there are tons of people out there who are in debt up to their eyeballs and have nothing to fall back on. On the other hand, if you’re sitting on more cash than you truly need, then you’re paying a ton of unnecessary interest while earning a pittance from your bank.
My advice: If you think I might be talking about you, sit down and carefully consider how much money you really need to have sitting in the bank. $1000? Six months of expenses? Twelve months of expenses? The “right” answer will vary. But if you’ve got more than that amount stashed away, use the excess to attack your debt.
Disclaimer: Discover is a paid advertiser of this site.
Reasonable efforts are made to maintain accurate information. See the Discover online credit card application for full terms and conditions on offers and rewards.
Modified on March 30th, 2011 - 19 Comments
Filed under: Debt Reduction
About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!
Related articles...
» Weekly Roundup – Mailing Articles Edition» How to Avoid ATM Fees
» HSA Fees: Don’t Be Penny Wise and Pound Foolish
» Weekly Roundup – 10/13/06
» Help a Reader: Buy a House or Wait?
» Pay Off Debt or Invest?
» Get the Best Mileage for Your Car-Buying Dollar
» Kids as a Tax Dodge
Was this article useful? Please sign up to receive our content via e-mail:
19 Responses to “Debt Reduction: Penny Wise and Pound Foolish”
Leave a Reply
Top Cards by Category
Earn 100 Reward Dollars after you make $1,000 in purchases in the first three months of Cardmembership.
Earn 25K Membership Rewards(R) points after you spend $2,000 during your first three months of Card membership.
Consumer friendly credit card with a great low rate of 7.25% and save on interest charges. No balance transfer fees and no annual fee.
The new Discover it card is out to change the way people think about credit cards. No annual fee. No overlimit fee. No foreign transaction fee & no pay-by-phone fee. No late fee on your first late payment. And Discover won't increase your APR for paying late.*
The new Discover it card is out to change the way people think about credit cards. No annual fee. No overlimit fee. No foreign transaction fee & no pay-by-phone fee. No late fee on your first late payment. And Discover won't increase your APR for paying late.*
Consumer friendly credit card with a great low rate of 7.25% and save on interest charges. No balance transfer fees and no annual fee.
Limited Time Offer: Get 25,000 Membership Rewards(R) points after you spend $5,000 in the first three months of Card membership. Enroll and select a qualifying airline to receive up to $200 annually in statement credits for incidental fees, such as checked bags and in-flight refreshments, charged by the airline.
The new Discover it card is out to change the way people think about credit cards. No annual fee. No overlimit fee. No foreign transaction fee & no pay-by-phone fee. No late fee on your first late payment. And Discover won't increase your APR for paying late.*
- How to Become a Millionaire
- How to Get Out of Debt
- The Best Dollars I've Ever Spent
- How Our Estate Plan is Structured
- How We Paid Our Mortgage In Less than 10 Years
- Money Making Ideas
- How to Manage Your Asset Allocation with Multiple Accounts
- Consumption Smoothing - Save While the Saving's Good
- How to Save on Groceries
- How Much Life Insurance Do You Need?
- Eleven Great Books About Money
- Dave Ramsey is Bad at Math
- Dish Network Customer Service SUCKS
- $8,000 Homebuyer Tax Credit
- Pay Off Mortgage Early or Invest?
- How to Claim the First-Time Homebuyer Tax Credit
- Termite Control: Sentricon vs. Termidor
- How Much Should You Pay a Babysitter?
- Ethanol Blended Gas = Lower Mileage?
- Reduced Credit Limits? Share Your Experience
- $15,000 Homebuyer Tax Credit
- Will Mac OS X Lion Kill Quicken 2007?
- Buying Furniture off the Back of a Truck
How to save money on insurance
- Working longer: Fallback or fallacy?
- More money, more happiness: Do you think money can buy happiness?
- Overdraft fees soared to $32 billion in 2012
- How do you combat prom inflation?
- How should you choose a bank? Look in the mirror.
- The cost of clean water
- College debt 101
- Is it possible to live debt free?
- How to prepare for a home appraisal
- Home prices are up: good news or bad?
September 4th, 2009 at 10:09 am
It’s really all accounting guys. My co-writer has about $500,000 cash in the bank, that throws off $22,000/yr in interest income. He also has probably an equal amount of that in rental mortgage and school loan debt, but that debt cost is about the same.
Right now, “cash is king.” So don’t go using up all your cash to eradicate debt b/c what if you get eradicated one day by your employer?
Shogun
September 4th, 2009 at 11:07 am
Nickel: My only debt is my 15-year mortgage. I have 6-months worth of cash in the bank. My only investments are my Roth-401k up to the company match.
Took me a few years to go here. I think 6-months of cash is about right for my family — I’m about to start throwing my extra cash-flow towards paying off the mortgage early.
September 4th, 2009 at 11:57 am
Shogun: That’s a 4.4% return. I’m assuming that they’re doing a lot more than just stashing the money in a savings account — perhaps they bought longer-term CDs a year or more ago? Also, mortgage and school loan debt aren’t exactly high interest. I’m talking here about people carrying high interest credit card debt (@ 15-20% or more) while at the same time sitting on more cash than they really need. Believe it or not, I really do get e-mails from people in this sort of situation.
September 4th, 2009 at 2:21 pm
This is a timely piece. It’s also important to consider how much liquidity is enough even if you have no debt.
My experience tells me that many people are less concerned about being too liquid right after the market has soaked them. They are more concerned about this when the market is hot.
In reality, we should all reverse the order – a tall order but financially sound.
September 4th, 2009 at 3:06 pm
I have been wondering about this lately. We are young, and our only debt is a fixed mortgage. Do we dump our excess cash slowly into the fixed mortgage, quickly into the mortgage, or stash-and-save for a larger goal (in this case, buying up a little cabin someday when the stash is significant)? This is above and beyond the “emergency fund” amount, of course
So far, I’ve been putting extra towards the mortgage monthly and saving the rest
I have no retirement investments—just an online savings account—very conservative (read: afraid) of that stuff!
September 4th, 2009 at 5:52 pm
Sorry to twist the subject but what about when all the high interest debt is gone?
Dave Ramsey likes focusing on paying off your mortgage. I just can’t bring myself to do that. Even with the bleak market I can’t help but believe that with a low fixed interest rate on the mortgage that my money is better off long-term in the market.
What do you think Nickel?
September 4th, 2009 at 7:51 pm
Hi Nickel,
Yes, he’s got several laddered 5 year CD’s between 4% to 6%, and so do I. Citibank today is offering a 5 year, 4% CD too btw.
I guess I may not be the target demographic to answer this question b/c I’m completely just living off my interest income. I do believe it is absolutely RIDICULOUS someone could keep a 10%+ oustanding CC debt if the savings rate is 4% or less.
Frankly, are there people who keep an expensive outstanding balance and have a lot of cash? I don’t know…. and I don’t think there are very many if there are, b/c that would be so irrational.
But, if there are, it’s best to come up with a 12 month plan to slay that debt, while not using up all your buffer.
Shogun
September 4th, 2009 at 9:37 pm
Shogun: “A lot” is relative. When you’re paying 15% interest, any extra money sitting around earning 2% is a *bad* thing. And yes, there are people doing this. Irrational, yes, but I get why they’re doing it. It’s comforting to see a decent chunk of money sitting in the bank even if it’s not technically yours.
Also, FYI: Citi’s 5 yr rate is currently 3.5% APY.
September 4th, 2009 at 9:40 pm
Greg: Excellent question. I’ve written about paying off your mortgage early a couple of times, and there have been some great discussions.
Click here for a Google site search for relevant articles: link
The bottom line for us is that we’re sorta playing both sides. We’re investing aggressively (above and beyond our retirement accounts), but also paying something extra toward our mortgage every month.
September 4th, 2009 at 11:30 pm
I doubt many people are sitting on a huge pile of cash, while at the same time having large amount of credit card debt.
But, I’d bet that people are sitting on large investments (stocks, IRAs, 401ks), while at the same time having large amounts of credit card debt.
If you were debt free, would you max out your credit cards to invest in the stock market? If not, then sell the stock and pay off the debt! I wonder how much ‘leverage’ is priced into the stock market because of people doing this…
September 4th, 2009 at 11:44 pm
Nickel – Guess Citigroup is up to their usual ways and carving up their product offerings. I just deposited some cash today, and they still have the 4% 5 yr CD sign up.
The real question is what you do between your cash pile and your low interest loans.
The answer is obvious regarding paying off 10%+ debt as fast as possible.
Have a good weekend!
September 5th, 2009 at 11:34 am
Hey Nickel – I’m sending a shout out to you and this post next week. Hope you enjoy the read.
RB
September 5th, 2009 at 3:10 pm
Great topic..yes, I am sitting on some cash, but not enough to pay off my debt. My reasons for not paying off my huge debt, is due to family issues. I am keeping it there sitting (sadly) until the “storms” pass.
It is killing me not to pay down this debt. Sorry not to give details. Jut writing this out was healing for me.. : )
September 6th, 2009 at 7:24 am
I think there are different ways to look at this. I periodically buy stuff and put it on a low interest credit card, knowing that I will pay it off when I get a bonus or options maturing. I have more than 6 months living expenses and it is in various securities that I am just not ready to sell.
The important point is to watch your interest rates. As your article mentions – don’t sit there and pay riduculas interest rates. Also, watch your debt to equity ratio. Secured debt, such as home mortgages, is not bad.
Its just a numbers game….
September 6th, 2009 at 9:32 pm
Oh what a lovely query – and one I wish I was troubled with at the moment. Currently I’m still in the ‘get out of debt’ phase of my monetary journey so this isn’t a question that I am personally pondering for a while yet.
However, as your rightly say given the current climate, I think at least 6 months living expenses is a sensible target. The chances of remaining unemployed (completely) beyond that is hopefully minimal.
I’ve paid off my highest debt (16.9% credit card), and I’m now working on my 8% loan. The remaining credit card is 0% so I’m just paying off the debt divided by the interest free period on that.
One of these days soon, I hope to face this part of my journey.
September 9th, 2009 at 4:37 pm
Nickel,
Like the premise on the article, but a suggestion for improvement — throw some real numbers out there for talking points. What’s “high”? Pick a number and talk about why it’s high.
September 10th, 2009 at 9:20 am
This is a great post with some really good commentary from readers. I like the suggestion of making the article more specific using exact #’s because what exactly is “too much cash?” I am a CPA by trade and am obsessed with personal finance in my free time. However, this is a very difficult question to answer and one that must be analyzed on a case-by-case basis per individual. Especially during the past 12 months where many employers are laying workers off and not many companies are hiring, that emergency fund that was 3 months may need to be 8 months. Keep up the good work, Nickel. By the way, I cam to this site via http://www.mainstreet.com an affiliate of http://www.thestreet.com – good work on the Advertising!
October 10th, 2009 at 6:23 pm
I believe that persons should pay off their debt if they have the excess of money inside the bank. Once this is eliminate then they can start rebuilding that account as a debt free person. A financial free life is better than a debt burden one.
January 19th, 2011 at 11:32 am
I have about $4,400 in an IRA, making .35% interest. I have about $20,000 in credit card debt, which I have worked out a budget for and am chipping away at slowly, but methodically. I have about $7,200 on one credit card that I am paying 16.9% interest on. Due to the economy, my income has dropped pretty sharply, so I have been currently making only minimum payments on all cards but one, trying to get rid of that one and move on to the next using the snowball effect. Would it be wise to cash out the IRA, take the tax hit and use that money towards the highest interest card? Once my credit card debt is gone, I will have plenty of cash flow to start saving more aggressively. I should mention that I am self-employed, so don’t have to worry about being laid off, just worry about a slow market. I am usually very good about my credit card debt, but unfortunately, again because of the economy, I had no other choice but to put some necessary expenses on the credit cards. These are not buying a new wardrobe and going out to dinner charges!!