Monday, December 3, 2007

And the lightbulb goes on...

Last month, I wrote about the allocation of my budget to different categories, and how it differs from my "ideal" allocation. One of the biggest points that stood out for me was that I use 12.9% of my gross income for debt repayment.

Get Rich Slowly has a review today of the book All Your Worth, and there's a point made that really jumped out at me. The target budget allocation recommended in this book is 50% for "needs", 30% for "wants", and 20% for savings. The big eye opener for me is that they include debt repayment in the savings category.

This concept of debt-reduction-as-savings isn't exactly a new idea to me, but it doesn't seem to have sunk in, because I list my debt repayment under my "needs" category. If I look at it as part of my savings, then I am actually saving 22.3% of my gross income (9.4% actual savings; 12.9% debt reduction). I think it's fair to look at it this way, for a few reasons:
  • These debts represent money that I've already spent, so I'm really saving up for these purchases retroactively

  • Every dollar that I pay toward debt reduction is a dollar that my future self won't have to pay (actually, it's more than a dollar that my future self won't have to pay, because every dollar that I don't pay now will accrue interest over time)

  • Once the debts are fully paid off, this is money that can be redirected toward "real" savings
So my budget allocation is actually a bit more in line with my target allocation than I thought.


MEG said...

I have always counted my mortgage pre-payment as part of my savings. This is because I don't HAVE to pre-pay my mortgage--it's optional. Plus if I wasn't doing that, those dollars would be saved instead.

But I don't count other forms of debt repayment as part of my savings; I'd call credit card payment, student loan payments, and car loan payments under "committed expenses" or "fixed expenses," just like any other bill.

The only caveot would be if you're paying EXTRA on your student loan payments or car payments--that portion could be referred to as savings. But credit card debt (even if you're paying more than you "have" to) can never really be considered a form of savings in my opinion.

Loonies And Sense said...

You're right about debt reduction being a "committed expense", in the sense that it's not an optional payment. If I ever find myself unemployed, I'll still have to continue making my debt payments.

Making these payments is, however, an investment in my future, so it sort of falls in a "mandatory savings" bucket. My main reason for thinking of it this way is that I am the number-one beneficiary of making these payments. Once the debt is paid off, these payments will be snowballed into my tithing and savings categories.

Whether or not you consider these payments as savings, they are different from other bills, in that each payment reduces a future obligation. You can't say the same for a tax bill, for example.