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​Should you focus on paying off debt or saving for retirement?

It’s one of the most commonly asked financial questions, but there’s no definitive answer that financial experts all agree on: is it better to focus on paying down debt, or is it more important to save for the future?

The simple reality is there’s no one-size-fits-all solution to this common conundrum, because individual circumstances vary so widely, and have such a significant impact on each person’s most appropriate answer.

In general, however, the best reply to the question of debt retirement versus retirement saving is that it’s best to do a mix of both, tailoring your choice to suit your current financial situation, and adjusting your strategy as that situation changes.

Starting early is best for both

Debts are at their worst when they’re big, because more of your repayment goes toward interest than the part that goes to paying down the principal. Thus, the sooner you can maximize your contributions toward a sizable debt, such as a mortgage, the sooner you can get to the point where more of your money is paying down the loan principal, reducing your overall interest burden by tens of thousands of dollars in the long run.

On the flip side, however, there’s no better time to start saving for retirement than right now, maximizing the benefits of compounding interest. If you’re investing your retirement savings in financial markets, starting sooner gives you more time to overcome the impact of any short-term instability and make the most of long-term market gains.

If you don’t save something, you risk deeper debt

While putting money away for retirement, it’s also wise to stash some cash in a high-interest savings account, giving you an emergency fund you can tap into in case an unexpected financial emergency risks plunging you into deeper debt. If your car or home need sudden repairs, or you find yourself out of work for a while, your emergency fund can help you avoid adding months or even years’ worth of debt repayment to your existing financial burden.

Assess your debt before deciding on a path

For many people, debt is a dirty word, a situation they feel uncomfortable in and desire to get out of as quickly as possible. However, not all debt is created equal.

Some debt, such as credit card debt, typically comes with punitive double-digit interest rates attached, meaning it’s smart not to let spiral out of control. On the other hand, many common personal debts such as mortgages, car loans, and student loans generally have interest rates lower than 9.3 percent, the average annual rate of return on the S&P/TSX Composite Index (TSX) between 1960 and 2020.

Interest rates have been low for the past decade and are likely still a year or more away from edging up as the world economy recovers from the COVID-19 pandemic. If you can earn more for your future by investing money in a retirement fund than you can save by paying down debt in the present, it’s smarter to save now and deal with your low-interest debt later on. If rates rise and market returns fall, change your strategy to reflect the current financial realities.

Remember: it’s never an either-or decision

If you have debt, you don’t ever want to neglect it. Create a budget and set up a repayment plan, if necessary, that ensures you’re meeting the minimum repayment requirements while still diverting at least a few dollars toward saving for the future.

If you have an employer who matches or adds to your retirement contributions, make sure to take advantage of the opportunity to earn free money. Even if the monthly contributions you make to your retirement are modest, don’t be discouraged – they just need time to grow. Your future is far too important to ignore, so don’t forget to plan for it.

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