"I'm in my mid 20's with buy now, pay later debts as well as a personal loan. I would like to pay these debts off as quickly as possible, but I still want to save for future investments. What is the best way to do this?"
- Question from Liam in Sydney
Top answer provided by:
Robert Daniele
To answer this question, I thought I would list a stepped process below of how I would approach it however, finances are different for everyone and how they manage them – there is not a one-size-fits-all approach, but I do like when things are kept simple!
Step 1 – Do a budget
Now this budget doesn’t need to be “hard and fast” that makes your everyday life feel daunting and something you have to stick to every hour of the day. What it will do though is give you an indication of what money is coming in, what money is coming out, then finally how much money is left over (a surplus) or how much money isn’t left over (a deficit). Now this surplus for example could mean you have the saving ability of $5,000 p.a. or you have a deficit of $5,000 p.a. which means you are living outside of your means and will continue to get into more debt.
You can’t really move past step 1 if you complete a budget and you are in a deficit, meaning that what is being spent every year is more than what comes in.
If you are in a deficit - I would start by trying to reduce some living expenses with the things like utilities – i.e. can you switch phone providers or electricity companies to make any savings? I would then move on to the “nice to haves” and see if you can free up some extra money by reducing these.
A good budgeting tool I like to use is Moneysmart's budget planner.
Step 2 – The debts
After step 1 is complete, it is good to then write down on a piece of paper what your debts are, the cost (repayments), any interest and how they arose to really get an understanding of your financial position and help you make decisions. I have an example below:
Example 1
Personal Loan
-How much? = $10,000
-Interest rate = 12%
-Repayments = $3,000 p.a.
-Remaining term = 5 years
-How did the debt arise? = You needed a new car to get to and from work
Buy Now Pay Later Debt
-How much? = $600
-Interest rate = Nil – only late fees
-Repayments = $200 p.f.
-Remaining term = 6 weeks
-How did the debt arise? = You went shopping for some new gym clothes
Step 3 – Looking at the debts vs risk and return of investing
Buy now pay later debt – From the example above, it looks like this debt didn’t arise from “an emergency” and looks more like general living costs. These can really confuse the budget and get messy when you start incurring late fees. Before you start investing, I would look to clear this debt and firstly see if you can start saving for these discretionary purchases for new clothes.
Personal loan – When you still have this personal loan and the interest is quite high at 12%, it makes it a hard financial decision to invest as generally the interest rate you are paying at 12% is potentially higher than any returns you may get from investing. To earn a higher return than 12% from investing requires significant risk that I wouldn’t usually recommend to someone who has a personal loan that has a high interest rate.
Summary
Once you have worked out your budget and analysed your debts, as above, it is time to start working out how to allocate the extra money - whether that is $10 per week free, $50 per week or more. From there you can look to start clearing your debts bit by bit. Once your debts are gone, I would then run a “test” before investing. This might mean setting yourself a goal of saving $1,000 for a whole month in a savings account, if you can do this without getting into more debt, it might be time to then start investing into longer term assets that come with more risk than a savings account but will provide greater potential for higher returns in the long term.
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