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Balancing saving and paying off debt has a plus side

By HELEN HUNTLEY
Published June 4, 2006

Balancing competing priorities is one of the toughest challenges for anyone trying to get fiscally fit. Do you pay down high-interest credit card debt or sign up for the 401k plan at work?

If you're getting socked with 18 or 22 percent interest on credit cards, paying them off first might seem like a no-brainer. But one of the things I've learned in two decades of writing about financial issues is that all-or-nothing approaches rarely turn out to be the best. Good solutions take into account the emotional issues tied up with money and the math.

"You'll feel better seeing your 401(k) balance grow," said Jonathan Pond, a Massachusetts financial planner and author who spoke at a retirement conference in Washington, D.C., I attended last month. He said - and I agree - that splitting your available cash 50-50 between debt payoff and retirement is a smart way to go.

Pond's theory is that it's important to cultivate a savings habit, particularly for young workers. You can get addicted to the good feeling of seeing that account grow. That addiction, in turn, can help you stay motivated to make the sacrifices achieving your goal requires.

My theory is that saving for retirement through automatic payroll deduction takes away some of the temptation to go astray. If you intend to write a check toward debt repayment each month, you might not follow through with it. If the retirement money never touches your hands, you've taken away the option to spend it on something else.

There are some mathematical reasons to put money toward retirement, even if it means debt payoff will take longer. For one, many employers match 401(k) contributions. In a typical case, you earn 50 percent on your contribution immediately, plus your investment return. For another, starting young means more years for your money to compound and grow.

But what if your dilemma is whether to save for college or retirement? Pond says to save for retirement and forget about college. His theory is that the kids can get scholarships and loans, but you can't get either to pay for retirement.

That's where Pond and I part company. While I think retirement accounts should get most of your savings, I favor setting up a college savings account and making modest contributions if that's all you can afford. (A 529 plan is the way to go, but that's a subject for another column.)

For one thing, once you have an account open, you might get the children's grandparents to chip in. For another, knowing savings are there for them will encourage some children to aim high in their academics.

Saving for retirement can be done in conjunction with working toward any financial goal. I can't promise you that just a little savings will provide a great retirement, but if you are living on Social Security, even a little savings will be a great blessing.

If you save just $50 a month and earn a 5 percent return, in 25 years it will be worth $29,775 and in 40 years you'll have $76,301.

Where can I find preferred stocks that pay really high yields?

If they pay really high yields, they have really high risks, so that's probably not what you want. Most high-quality preferreds yield between 5.5 and 6.5 percent, according to Dow Theory Forecasts newsletter. When you get into 10 percent territory, you are taking on considerable credit risk.

Some investment newsletters offer recommendations. Two good Web sites with information on preferreds are www.quantumonline.com, which is free, and www.epreferreds.com, which has a subscription fee.

Another way to invest in preferreds is through a mutual fund. Two mentioned in the Forecasts are closed-end funds, Flaherty & Crumrine Preferred Income Opportunity and John Hancock Preferred Income.

Be sure to investigate thoroughly before parting with your money for any investment.

Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to hhuntley@sptimes.com to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731, or log onto www.sptimes.com/blogs/money where you also can see other questions and answers.

[Last modified June 2, 2006, 12:09:18]