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Save Up vs. Spend Down

Picture of Erica Neal

Erica Neal

Erica was born & raised in west Texas, graduating from Permian High School (the school from “Friday Night Lights”). She went on to earn her bachelor’s degree in Finance & Economics from UT Permian Basin. After college, she moved to the DFW area and began her career in finance by working for a large investment firm. She learned the basics of running a financial practice but also saw large holes in the company’s planning process from early on.
Save Up vs. Spend Down



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Debt is not just part of our lives, or even our culture. It could be argued that debt is hardwired into us as human beings. Loaning and borrowing transaction records can be traced all the way back to biblical times and even ancient Egypt. Credit cards were launched in the early 1920’s through department stores offering “courtesy cards” for purchases within their store. This set off a trend, creating a domino effect leading to “diner club” cards in the late 1920’s and then in 1958 Bank of America initiated mass competition by issuing a credit card accepted by a wide variety of merchants. This credit card was only utilized in California for several years, but in 1966 it finally ventured to other states.
This new method of purchasing spread quickly creating new opportunities, as well as new problems. Obviously, we can see the impact credit cards have had on our society decades later, but we need to understand the ripple effect of this issue.
Generation X (which are those born between 1965-1980 according to Business Insider) was undoubtedly hit the hardest by the credit card crisis.
Based on 2019 The Fiscal Tigerreport with data collected from multiple sources, including Experian, Generation X has the most credit card debt of any age group. “Most Gen Xers got their first credit card by the age of 24, so they are programmed to use plastic,” says Melissa Davidson at The Fiscal Tiger. This generation was the first young group exposed to credit cards, had no guidance or understanding of the usage implications, and have since then been chewed up and spit out with plenty of debt and PTSD to spare. This is why there are so many “debt gurus” who are fighting to be #1 on the FM/Sirius radio stations or weasel into churches to launch their own groups. These gurus know this is a widespread problem that affects an entire generation so why not capitalize on it? So now, we have a large group of people terrorized by financial struggle, being shown a shimmer of light at the end of their tunnel, being led to a “financially free” lifestyle on the chassis of paying off every debt as fast as possible. Not to mention, GenXer debt warriors have been and continue to recruit the next generation by levying the same debt-free idealism on their children
Can we pause here to clarify something? Please hear this message that paying off debt is not a bad way to spend money. In all transparency, my parents were terrible at finances and budgeting which led them into serious debt. They did attend some church classes, read the books, and followed the programs which helped them climb back into a sense of normalcy, so I am forever thankful for that. I completely understand and have lived in the ominous presence of debt hanging over every aspect of life.
But ALL DEBT IS NOT CREATED EQUAL. The concept of budgeting, living within your means, and paying off credit card debt is foundational (you don’t have to pay hundreds of dollars to know that). However, allocating every dollar towards paying off or even avoiding interest (specifically low interest) has a much higher extrinsic cost than what most realize. Herein lies the problem. In my financial planning experience, all too often I have met individuals ready to head into retirement with their house, car, and whatever other liabilities they had paid off.
This is a great accomplishment but unfortunately, it is typically partnered with the car having 120,000 miles on it, and needing regular repairs. The home also has regular maintenance requirements as well as ongoing taxes, insurance, and utilities. The kids are out of the house, but grandkids come along and other basic living expenses still seem to come rolling in. So, although their debts have been paid their savings are minimal leaving them in a struggle to create reasonable cash flow. There are only two options when it comes to the utilization of money: you can either pay interest or lose the ability to earn interest. That’s it. To know where the equilibrium of cash flow falls and how money should appropriately be allocated, we must understand the way money works.
Money and math are very different which cause confusion in basic financial understanding as most of us are trained to think mathematically. Let’s dive into the two different calculations to consider when factoring in where money should be spent, and see where that balance falls.


This is a fancy word for “repayment plan”. Any loan taken out with a defined schedule and an interest rate will outline the payment terms using an amortization table. Basically, the principal balance is multiplied by the interest rate and as each payment is applied the principal balance is lowered by the amount of the payment which is not interest (AKA- principal payment). Below you will see an example of an amortization table for a 30-year mortgage loan of $300,000 at 3.99% taken out by Sandy Shell. As most people know, the initial payments of any loan primarily go to interest. In the example table, you’ll see Sandy’s first month’s payment of $1,430.52 had $997.50 go to interest and only $433.02 go to principal.
Example #1
Over the entire 30-year stretch, $214,986 goes to interest. Yes, that is a lot of money, but here is what’s interesting about loan repayments: The interest amount steadily decreases over time. Less and less of Sandy’s payment is diverted to interest so the principal balance wears down faster over time. If Sandy is concerned with the 3.99% interest being charged on their home, she may decide to put additional money into her mortgage each month. For the sake of my OCD, let’s assume Sandy puts an additional $569.48/month into her mortgage making her total payment an even $2,000. The table below shows what her new amortization schedule would look like.
Example #2
So now over the 30-year time period, Sandy has paid $116,119 in interest to the mortgage company. That is a savings of $98,867 compared to the first example of only paying the required amount. Sandy also paid off her home in 208 months as opposed to the scheduled 360 (month 209 only had a $119 balance so we’ll consider that negligible).
But what did it take to save that amount of interest? Overall the additional $569.48/month over 208 months totals up to $118,451.84. So, an additional $118,451.84 put into Sandy’s mortgage, only saved her $98,867. How is this possible? Remember how the interest is affected as payments are made. Less and less interest is paid with each payment made, therefore less and less interest is saved as over-payments are made. So in a valiant effort to be fiscally responsible, Sandy’s attempts are steadily offset by basic amortization calculations. This does not mean what Sandy is doing with her money is “bad”. In fact, there is a little phrase that I use regularly which deeply annoys my husband: “Nothing is good or bad until compared to the alternative”.
This statement is incredibly applicable to multiple areas, if not all of life (getting under my husband’s skin is just a bonus). With that consideration, let’s take a look at an alternative use of additional available funds.

Compound Interest

In this section, we will dive deeper into what Albert Einstein called “The Eighth Wonder of the World”. Of course, he was referring to compound interest and he could not be more right. The compound interest calculation is fascinating and highly regarded in all areas of finance. When understood, compound interest can exponentially increase savings superseding interest paid on debts. Sally Walker took out the same mortgage with the same terms as Sandy Seashell (seen in Example #1). But Sally also wants to put back the same even $2,000/month like Sandy did. However, Sally understands compound interest and wants to focus on wealth building instead of attempting to be “debt free”. So, Sally looks for a relatively safe market investment and decides to go with the Dow Jones Equal Weight U.S. Issued Corporate Bond Index. In Example #3 below you will see the average RoR for the Bond is 5.44% which is lower than other stock investment options and significantly lower than real estate returns. But we’ll just use this lower return investment for now. Sally then takes her additional $569.48/month ($6,833.76/year) and invests it conservatively. Compound interest is the exact opposite of amortization. To be more specific, the interest within the account goes TO the individual as opposed to coming FROM the individual. Also, the interest amount steadily increases over time. This means that the more saved, the more earned.
See Example #4 below to review how Sally’s yearly savings accumulate with interest.
As previously mentioned, the interest earned in the first couple of years isn’t anything to write home about (especially in this example because year 2 lost money). However, the overall account balance is increased each time interest is added. Then the interest is paid based on the new, higher account balance. This is how a consistent savings amount will exponentially earn more and more over time. In year 4, there is a 4.83 % return yielding $1407 in interest earned. Then later on in year 18 there is a 3.94% return that yields $7,898 in interest earned. That is more than $6,000 earned with a lesser percent return all because the account balance has compounded over time!!
In a 30 year time line, the $569.48/month was able to earn Sally $302,289 in total interest when it only saved Sandy $98,867 on her mortgage interest. Obviously the average RoR of the bond investment of 5.04% is higher than the mortgage interest rate of 3.99% so it would make sense that more interest is earned. What would happen if the percentage earned as less than the percentage paid? See Example #5 below to review how only earning 3.5% impacts Sally’s savings amount:
Example #5
Over 30 years, Sally earns $160,117 by saving $569.48/month at the lower 3.5% rate while Sandy still only saved $98,867 in interest by overpaying and applying the same $569.48 to her mortgage with a 3.99% rate. Even at the 208 month mark (approximately 17 years), when Sandy has paid off her home saving $98,867, Sally already has $160,597 compounding in her account which will continue to grow whether she decides to continue contributing or not.
There is a big difference between being “debt free” and “financially independent”. True financial independence is achieved when our income exceeds our expenses. When we are in control of our lives and where our money goes, the weight of financial burdens is lifted. However, too many confuse the message with the method. When people hear, “income exceeds expenses” they immediately think they need to lower expenses. What if the method used would increase income to an amount above expenses? In planning for retirement or a cash flow phase of life, there are a couple options.
For example, you could have $75,000 of income with only $40,000 of expenses. Or, you could have $60,000 in expenses with $200,000 of income. Focusing attention on paying off debt with minuscule interest rates means that those dollars are no longer able to go out and earn interest. Even if the interest rate of earning is less than the interest rate paid, it can still make sense to save up instead of spending down. The only way to find out is to run amortization tables and compound interest calculators to see how the numbers line up. In full disclosure, it almost always makes sense to payoff credit cards ASAP because the interest rates are so high it is almost impossible to earn more than what is being charged.
The two retirement scenarios mentioned just now do not have a right or wrong answer. I have honestly met some people who just do not want any payments and are ok with lower income, even if the bottom is lower and that is ok! The point is, understand where your money is going, how it is impacting your interest earned or paid and what your bottom line will be. Knowledge is power, but implementation is success.

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