Short-Term Savings Plans: The #1 Tool for Ending Bad Debt
With the average American carrying over $7,000 in unpaid balances, as a financial coach I am often asked the best way to pay off credit card debt. Of course, having a solid spending plan is the first step to ending bad debt. Afterall, learning how to live within your means, and not spending more than you make, is vitally important to end the cycle of bad debt and begin to build wealth. However, once you have done the work to have a balanced budget, the next step and the #1 tool for ending the cycle of credit card debt is what I call the short-term savings plan. I will explain my strategy to you today. If you follow this plan, you will be on your way to eliminating bad debt forever.
A Short-Term Savings Plan Holds Your Emergency Funds
As part of your overall spending plan, the goal is to save 20% of your income each month. It is recommended to put 10% minimum toward your long-term goals (retirement). The remaining 10% should be put to use based on your overall goals and time horizon. That being said, if you do not have an emergency fund that holds 3-6 months of mandatory expenses, your entire 10% should be utilized to build up these emergency savings. Do this before you start to pay down credit card balances. Not having ample emergency funds is the reason you have unpaid credit card debt.
A Short-Term Savings Plan Holds Your Money Buckets
When I ask my clients about what type of charges make up the majority of their credit card debt, they usually tell me it is for things that just tend to pop up and are unplanned expenses. The balances hold expenses for car repairs, home repairs, gifts for friends and family, vacation expenses, medical bills, clothing and dining out, just to name a few. So, even though these expenses are spontaneous in nature and do seem to come out of the blue, the truth is they always happen. Therefore, to get in front of the problem, we create money buckets. I ask my clients to make categories of these unplanned expenses by reviewinging the last year of charges on their cards. Each category gets its own funding goal for the year. Add up all the funding goals for all the categories and divide by twelve. This is the amount you should be depositing into your short-term savings account every month. Keep track of your money buckets, the amount that is funded each month, and the amount that is deducted to pay for these expenses. Having a fully-stocked list of money buckets is how we earn money from our credit cards, not the other way around. Use your credit card to get points, miles, or cash and pay off the balance in full every month from your money buckets. This is the trick for making your credit work for you. This is the way to end bad debt and build wealth. Fund your money buckets and keep track of them on a spreadsheet or other preferred tracking tool.
A Short-Term Savings Plan is Liquid
Liquidity is a term used to describe funds that are easily available and not locked down into investments or products that take time to sell or transfer funds. You will be transacting monthly into and possibly out of your short-term savings. Every month you will have money to put in. And, if you need to access funds from your money buckets or emergency, you will need to move money out of this account and to your bill-pay/checking account. Because these funds are earmarked for emergencies and annual expenses (not monthly expenses), they should not be invested in a brokerage account due to a short time horizon. The type of liquid account that should be part of your short-term savings plan is described below.
A Short-Term Savings Plan is in a High-Yield Savings Account
If you are currently using a savings account with your local bank, you may be aware of the very small interest rate you are being paid monthly. I want you to research online savings institutions that pay over 3% interest. Simply type in “high yield savings accounts” to your search engine and see what comes up. Some banks I know pay this rate are Barclays, Marcus, and American Express. You will want to set up electronic transfers so you can easily move money from checking to savings. In fact, if you set up automatic monthly contributions to this account, you are setting yourself up for success.
So, if you find yourself in a position of owing money on your credit cards, get this plan going today. The idea is to stop adding any balance to your cards by adhering to your spending plan. Once you stop the bleeding, start to fund your short-term savings account. Now you are on your way to eliminating the bad debt cycle and getting your finances on an upward trajectory.
Want to talk about this and other ways to move your money in the right direction? Schedule your free Q+A with me today.