The Commerce Department recently published figures showing the personal savings rate in January. It is now at 5% – the highest since 1995. It has increased from .1% – the savings rate a year ago. While this savings rate can be positive news for the economy over the long-term, an equally important concern is what that savings is used for.
Someone with debt is faced with a fork in the road: should the savings be used to create an emergency account, or be applied immediately to debt reduction efforts?
There is no clear answer, because it depends to a degree on the behavior of the individual struggling with debt. If an emergency fund is created (and consequently debt reduction is delayed), then the risk that the fund becomes tapped for non-emergency purposes is real. Even if the fund is used for genuine emergencies, it may be too tempting to rely on the stash instead of adopting a better set of behaviors that can improve one’s financial health over the long-term.
On the other hand, the new savings can be immediately applied to debt reduction. This is the best strategy for most people who revolve high interest debt from month to month, especially if they are fairly secure in their monthly income stream. Part of the added benefit to starting to reduce debt immediately is averting the compounded difficulty in completely eliminating debt as time passes.
Raj Patel writes for DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.
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