How to Make Your Money Work For You, Part 1: Pay Down Debt 💵

Today we’re going to start a series on making your money work for you.

Now, when somebody says they want to make their money work for them, they’re typically talking about making money from investments.  And that’s all good, and we’ll talk about those topics later this week.  I’ll go over the different types of investments and passive income sources and how you can make money from each.

But there’s a preliminary step we need to take before jumping into the world of investments.  See, investments are a way to make your money work for you in that they make you more money.

But just as important, and frankly sometimes even more important, is making your money work for you in a way that saves you money.  And by saves you money, I’m particularly talking about saving you money on interest payments to fat cat banks and lenders.

💸 Saving Money Is Arguably More Important than Making Money.

Did you know that saving $100 actually results in a greater economic benefit and net worth increase than making $100?  Yes, it’s true!  The reason why is taxes.  Let’s say you have a marginal tax rate of 30%.

Every additional dollar of income you make is taxed, so when you make an extra $100, you’re really only receiving an economic benefit of $70 because $30 of it goes to the government!  But when you save $100, you really are saving $100.  The government doesn’t tax your savings; that’d be double taxation!

So let’s say you have an investment that could yield you income of 7%.  So if you put put $1,000 into this investment, you could expect a $70 return.  Now let’s say you also have $1,000 of debt with a 6% interest rate, so you are paying the lender $60 a year.  Now let’s say that an extra $1,000 magically appears in your bank account.  What would you do with it?  Invest it or pay down your debt?

As a CPA, I know that there are some kinds of income that are tax-free, such as municipal bond income.  And there are some kinds of interest that are tax deductible, such as interest on business debt, mortgage interest up to $1.1 million principal balance, and student loan debt for those who make less $80,000 ($160,000 if married filing jointly).

So obviously this discussion is very nuanced, and I am just speaking in generalities.

Please don’t get me wrong here.  I’m not saying not to invest if you have debt.  No way!  I have debt, and I invest.  But if you have high-interest debt (interest rate is 10% or more), you need to focus on paying down that debt as quickly as possible before even thinking about investing.

To illustrate this concept, let’s talk about student loans.  Although what I’m about to say can apply to really any kind of debt, I know that one particular kind of debt plagues our generation more than any other, and that’s student loan debt.  So we’re going to talk about our imaginary friend Austin and take a look at his student loan numbers.  Here they are:

• Austin has $30,000 in student loan debt.  This is known as his principal balance, or the actual amount that his lenders gave him to pay for college.
• The term on his loans is 10 years.  This means that if he makes the minimum monthly payments specified by his lender, he will pay off his loans in 10 years.  Now typically, in the financial world, loan terms are considered in terms of months, so his loan term is more specifically 120 months (12 months/year x 10 years = 120 months).
• The interest rate on his loans is 6%.

Let’s plug those numbers into our trusty Loan Calculator below.  Go ahead.  I’ve already put Austin’s numbers in there for you.  Just press the blue “Calc” button at the bottom of the box.

[fcloanplugin sc_brand_name=”Austin’s Student Loans” sc_hide_resize=”Yes” sc_loan_amt=”30000″ sc_n_months=”120″ sc_rate=”6″]

See that number that popped up in the “Total Interest” box?  It’s $9,967.42.  If Austin just makes the normal monthly payments on his student loans, he’ll end up paying an additional $9,967.42 of interest in addition to the $30,000 that he originally borrowed to his lenders.  So instead of paying only the $30,000 that he borrowed, Austin will have paid $39,967.42.  That’s almost $10,000 more.  That’s $10,000 that he could have put toward those sexy, passive income-generating investments that we’ll talk about later in the week.

So what’s Austin to do?  Accept his fate like most of his Millennial peers?  No way.  Austin can make sure that he throws more than the minimum monthly payment every month toward his student loan debt so that he saves as much as possible on interest.

What if Austin could put just $100 more each month toward his student loans?  How much would he save?  Find out tomorrow.