Category Archives: debt management

Saving for Big Ticket Items

Like sands through the hourglass, so our the coins in our jars...

How much do you need to set aside each payday to save up for a big ticket item you will need to buy a few years from now?

Sure, you could do what a lot of people do and just pull out your credit card when it is time for you to buy that big ticket item, then spend the next several years paying for it and the interest your credit card company will charge you. But what if you would rather only pay once for what you know well in advance that you're going to be buying?

Better still, what if you set aside money every payday and earned a little bit of interest on it from that savings account at your bank? You wouldn't need to set aside quite so much, but all the money you would need would be ready when you're ready to pull the trigger on your planned purchase.

That's where our latest tool might be really helpful for you. Just enter the indicated data for your future purchase in the input fields below, and it will work out how much you will need to set aside from each of your paychecks until you have saved enough! [If you're reading this article on a site that republishes our RSS news feed, please click here to access a working version of the tool at our site.]

Big Ticket Item Price and Savings Information
Input DataValues
How much money are you looking to save?
What is the interest rate for your savings account?
Over how many years will you save before buying?
How often do you receive a paycheck?

Savings To Set Aside With Each Paycheck
Calculated ResultsValues
Amount to Save From Each Paycheck

For our default calculation, if you placed $126.69 out of every paycheck in your savings account and earned 0.8% interest on it, you would have $10,000 saved up after 3 years. If you change the interest rate to 0%, you'll find that you'll have reduced the amount you need to save by $1.52 per paycheck, which doesn't sound like much, but that's a $118.56 savings for you over three years.

If you can get a higher interest rate on your savings account, then the savings math may become more compelling. Alternatively, if you can find a way to get a discount on what you're looking to buy and are willing to adjust the timing of when you plan to buy, that will work in your favor too.

If you're wondering about the math behind the tool, it the same that big corporations use when they plan to set aside funds to pay dividends to their shareholding owners or to pay back money they've borrowed. They call these special purpose savings accounts "sinking funds", although we have yet to find a compelling explanation for why they're called that.

But you have to admit, they're an excellent way to ensure you have the money you will need when it is time to buy that costly, not-so-everyday item. Not to mention being easier to manage than three years worth of loose change tossed in a jar!

Image credit: Photo by Michael Longmire on Unsplash

What Is Your Personal Cost of Debt?

Credit Cards via Unsplash - https://unsplash.com/photos/RJQE64NmC_o

There are a lot of different ways to measure how deeply you might be in debt. You could count up all the individual credit accounts you have, such as your mortgage, your student loans, your car loan, and all your credit cards. You can also add up all the liabilities you've racked up on each of these.

But that doesn't necessarily tell you how much your personal cost of debt is. For that, you'll need to know how much you've borrowed for each of your credit accounts and the interest rate you are paying to have already borrowed what you have.

With that information, you can find what your personal cost of having debt is, taking into account how it is weighted among your different credit accounts. We've built the following tool to do that math for up to as many as six different credit accounts you might have open. If you're accessing this article on a site that republishes our RSS news feed, please click through to our site to access a working version of the tool.

Individual Debts and Interest Rates
Input DataAmount BorrowedInterest Rate
Credit Account #1
Credit Account #2
Credit Account #3
Credit Account #4
Credit Account #5
Credit Account #6

Your Personal Cost of Debt
Calculated ResultsValues
Total Liabilities (Total Amount You Owe)
Weighted Average Personal Cost of Debt

In the tool above, if you have more debt accounts you would like to include in the calculation, take the results from the first six accounts, enter the total and weighted personal cost of debt interest rate in under "Credit Account #1", then continue to add the information for up to five more of your additional debt accounts. Repeat this process as necessary, until you're done. If it seems burdensome to do this, you may want to seriously consider reducing the number of credit accounts you have open.

Once you are done though, what can you do with this information?

Millionaire Mob describes it as one of the most important decision tools for making personal finance decisions you have available to you:

Personal cost of debt is so important. I cannot stress this enough. This is a line in the sand that helps you understand if you should pay down debt or invest. This is the best metric for debt prepayment....

For your personal cost of debt, you want to do anything in your ability to pay down the highest interest rate debt first. Lower your personal cost of debt to 4.5% or lower. At that point, you can invest everything you have.

The long-term average of the stock market is approximately 6-7% per year. With taxes, this is basically an annual return of about 4.5%. Thus, for every dollar you put into the stock market you should exceed your personal cost of debt. Keep in mind interest rates could increase or decrease, so this is somewhat relative.

If your final result for your personal cost of debt was above 4.5%, then taking steps to pay down your loans makes sense, where your biggest bang for the buck will come in paying down the credit that carries the highest interest rate.

We'll also note that Millionaire Mob is taking inflation into account in looking at the long term rate of return for an investment in the stock market. Over its history, the long term average rate of return for the S&P 500 is 9.4%, with the long term rate of inflation averaging about 3.3%, though the Federal Reserve has targeted a 2.0% inflation rate in recent years, which is how you get down to an investment return of 6% to 7% before you might pay taxes on your investment returns, which then drops to Millionaire Mob's threshold of 4.5% after taxes.

If you have the ability to invest with tax-free returns however, such as through a Roth IRA or a Roth 401(k), the weighted average personal cost of debt threshold for choosing between long term investing and paying down debt would rise to 6.0%, where you should choose to invest over paying down debt with any "extra" money you might have if your personal cost of debt is below that higher threshold.

Image Credit: Photo by Avery Evans on Unsplash.