This post is a part of a new tagged series of posts that give my perspective on a number of common budget, debt or finances questions. I find these questions in several ways including Reddit and Facebook Groups.
Today I’m tackling a common question I see from people at the start of their debt free and financial independence journey’s.
Focus on first getting a starter Emergency Fund
A fully funded Emergency Funds generally should cover 3-6 months worth of expenses, however this may be different for each individual. Regardless of the amount a fully funded Emergency Fund typically represents a substantial amount of money for someone to come up with, and it will take significant time to complete. If the person saving for the Emergency Fund has consumer debt they will likely be incurring interest during this time. Its for this reason why building a starter Emergency Fund first, and then prioritising consumer debt payment sooner over a fully funded emergency fund may be a better option.
How much should my Starter Emergency Fund be?
There are a number of different school’s of thought on how much your starter emergency fund should be. For example:
- The Barefoot Investor recommends that your starter Emergency Fund should contain a minimum of $2000 before tackling debt.
- Dave Ramsey recommends a starter Emergency Fund of $1000 as part of his baby step method before tackling deb.
What amount you choose to go with for your starter Emergency Fund is ultimately up to you as this will be different for everyone.
Prioritise getting your Starter Emergency Fund fully funded
Once you’ve settled on your starter emergency fund amount its time to pay minimums on all your debt payments temporarily. That way you can prioritise all additional funds to your starter emergency fund, and knock it off as quickly as possible. If you are going to struggle to get your starter Emergency Fund completed in less than a month think about some ways you could speed up the process. This could be selling items you no longer need or use, side hustling, or some other creative way to raise the funds.
Prioritising consumer debt
Once you’ve got your starter Emergency Fund in place its time to prioritise your consumer debt (excluding mortgage debt). By consumer debt I mean debt such as credit card, student loans, car loans, and short term loans (like payday loans).
There are two approaches to prioritising debt:
Debt Snowball: You list and prioritise paying off your debts from lowest balance to highest balance, and you focus on paying off the smallest one first (regardless of the interest rate). On this method you only pay minimum repayments on your other debts, and put all additional funds to the smallest debt. Once the smallest debt is paid off you then focus on the next smallest debt, and so on and so forth until all your debts are paid off.
Debt Avalanche: You list and prioritise your debts by highest interest rate to lowest interest rate, and focus on paying the debt with the highest interest rate off first. With this method you only pay minimums on the lower interest debts, and put all additional funds to the debt with the highest interest rate. Once the debt with the highest interest rate is paid off you then focus on the debt with the next highest interest rate, and so on and so forth until all your debts are paid off.
Which option is best?
The simple answer is the one that works for you, and you may start a method and switch to the other during your debt payoff. As long as the method works for you who really cares which one is best.
That said the Debt Snowball method has the greatest chance of success from a psychology stand point, and the Debt Avalanche method will result in less interest being paid overall.
It may be worth using a calculator to enter in your debts and compare your options against the methods. I have created one for this purpose (link here) or you could create your own.
Track your progress
Regardless of where you are with in reaching your financial goals whether that be paying down debt, saving or investing I recommend tracking your progress. All debt free journey’s feel slow at times so tracking your progress via a visual chart can really keep you inspired to keep going (its a marathon not a sprint remember).
You can find visual charts easily available online and there are a tonne of free ones click here for a link to my favourite ones from Debt Free Charts.
I also have a free investing printable available here or a free savings printable here.
If you’ve got a question you would like me to cover feel free to complete my contact form. If you would like to have articles like this delivered to your inbox subscribe below.