What Would You Do? #8

Feb 18, 2017 by

dice with question marksA reader wrote recently with this question:

I’ve been gifted $15,000 and want to use it wisely. What should I do?

She (let’s call her Jennifer) offered this background information (I’ve altered some details to protect the reader’s privacy):

  • Jennifer has $5,000 in credit card debt.
  • She’s in her late 20s, self-employed (a small business owner), married, with a 3-year old.
  • Jennifer has Roth IRA and 529 accounts, but has saved very little so far in each. She has no other savings.
  • I can tell that Jennifer is entrepreneurial—she would like to expand her business by adding e-commerce and sharing her expertise through training others with aspirations in her field.
  • Jennifer and her husband would like to buy a home, and have been working toward that goal.

My Suggestions for Jennifer’s $15,000 Gift

Below are my suggestions to Jennifer. But the goal of this post is to solicit your suggestions so Jennifer has more than one guy’s opinion to consider. Please critique my suggestions and add your own in the comments. Thanks!

Hi Jennifer,

Some thoughts for you to consider:

  • If the APR on that credit card is over 5%, I suggest strongly you pay off the entire $5,000 balance. Let’s say the APR is 19.9%. A $5,000 balance would be costing you about $1,000 a year in interest expense. If you pay it off, you can recapture that $1,000—about $85 a month—and use it to make more progress toward your other worthwhile goals. By design of the credit card company, you won’t pay off a $5,000 balance for decades if you make the minimum payment. Here’s the most important part: once you pay off the balance, continue to pay the balance in full every month so you don’t waste precious cash on credit card interest.
  • Next, if you don’t have an emergency fund, here’s your chance to establish one. It’s tough for me to say how large of an emergency fund you need, but for starters I’d recommend at least $2,000. (You can read my “How Much Emergency Savings?” for more of my thoughts.) An emergency fund will mean you’re less likely to have to pull out the credit card for big, unexpected expenses, which means it’s less likely that your credit card balance will grow to more than you can afford to pay off in full every month. If you need to, literally open a separate bank account for your emergency fund so you don’t spend it except for something it’s intended to be used for.
  • Congrats on opening the 529 and Roth—both are important. However, I think the Roth is more important right now. I think you should put the maximum allowed into your Roth—that’s $5,500 for 2016, and you can still make a 2016 tax year contribution to your Roth until April 15, 2017.
  • Consider next starting a house fund. Even if you end up not needing a down payment or closing costs, you’ll find plenty of things you’ll want and need to spend money on when you move into a house. Again, open a separate bank account if you must to keep yourself from spending from this fund. Let’s say you jump-start this fund with $1,000.
  • Use some amount—$500 say?—and treat your family. For me, experiences make better treats than “stuff,” but you may feel differently.
  • For the remainder (about $2,000), you could set aside some to invest in expanding your business or furthering your (or your husband’s) education or training to grow your income long-term, contribute to the 529, put some in a holiday fund so that 2017’s Christmas doesn’t end up on your credit card, set aside some for a car fund so that when a car next needs replacing, you can pay for it borrowing as little as possible, and so on.

I hope you see a common theme here: Plan to avoid high-interest debt as much as possible. High-interest debt is what kills most people’s finances and is like a ball & chain, making it so much harder to succeed and meet goals. That $5,000 in credit card debt is sucking life out of your monthly budget in the form of nearly $100 a month in interest costs. By paying off the balance, the extra cash will make a big difference in the progress you can make toward your goals. Said differently, if you use your $15,000 gift to pay off high-interest debt, you’ll be parlaying it into a much larger gift. Think of it this way: if you would be saving $100 per month in credit card interest by paying that $5,000 credit card balance to zero, your $15,000 gift really is worth $15,000 + $1,200 = $16,200 over just one year because you will have saved $1,200 in credit card interest costs during that year because of the gift.

Best of luck,
Kurt

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