Don’t keep debt around like it’s a Pet Rock

For those too young to remember, there was once an entrepreneur who actually got more than a million consumers to pay $3.95 for a “pedigreed” Pet Rock.

Gary Ross Dahl, who created the Pet Rock in 1975, even had an instruction pamphlet for the care and training of the stone, which came in a cardboard box with air holes.

“Your PET ROCK will be a devoted friend and companion for many years to come,” the instructions said. “Rocks enjoy a rather long life span, so the two of you will never have to part … Once you have transcended the awkward training stage, your rock will mature into a faithful, obedient, loving pet with but one purpose in life — to be at your side when you want it to, and to go lie down when you don’t.”

For many people, their debt has become like a Pet Rock. It has matured into a faithful companion that has been hanging around for years. And this can be the case even when they have the money to pay down the debt.

The Pet Rock phenomenon came to mind recently when I received a question during my weekly online discussion.

Q: We have about $70,000 left on a student loan, with no other

debt. We have the cash on hand to pay it off in full, but it would mean clearing out a few index funds and dipping into our cash savings. We have $100,000 in retirement funds, and maybe $20,000 in cash. No children yet, and we are in our early 30s. We are typically savers, and my spouse’s job is secure and stable, bringing in around $100,000 a year.

Is it a wise idea to completely raid our savings to pay this off, or should we hack away at the debt over time?

It’s important while you are paying off debt to keep some savings. If you don’t have any money set aside, and a financial emergency happens, what would you do?

The choice is often to use credit — debt — or borrow the money from a friend or family member. In fact, the Federal Reserve says 40% of Americans can’t cover a $400 emergency expense without borrowing or selling something.

But how much should you keep in savings versus paying down your debt?

Here are some things to consider before raiding your emergency fund and/or investments to get rid of debt.

Don’t ignore the need to have some emergency funds. Life happens, and when it does, the last thing you want to do is rack up new debt while you’re trying to get out of old debt.

How much you should keep in your rainy-day fund depends on the answer to at least one key question: Do you have a stable employment situation? For instance, if you’ve heard rumblings of layoffs, don’t deplete your cash savings to aggressively pay off liabilities in case you end up losing your job. Cash is king in such situations.

But if your employment is as secure as it can be these days, don’t park a huge amount of money in a savings account paying 1%interest when you have credit-card debt with a double-digit interest rate. So if $20,000 is all the cash that this couple has, I would advise them to hold back about $5,000 — or maybe one month’s worth of living expenses — and use the rest of the money to hack away at the student loans.

Ultimately, the goal should be to accumulate, if you can, three to six months’ worth of living expenses. But that’s a target you should aim for after you’ve gotten rid of consumer debt (excluding a mortgage).

Don’t touch any retirement savings. If you take money out from your 401(k) account or IRA before you turn 59 1/2, you incur a 10% early-withdrawal penalty, in addition to having to pay income tax on the distribution.

Don’t worry about falling behind in retirement savings — yet. The younger you start saving for retirement, the better. But most people retire in their 60s, so this couple probably still has three decades to save for retirement. Plus, once the debt is gone, they can take the money they were using to pay down the student loans to catch up on their retirement savings.

I know some will say — if the student loans are at a low-interest — that it’s better to invest and keep making the scheduled payments. I would argue that’s Pet Rock thinking.

If you have the means to be free of debt, don’t keep it around like it’s a pet, or it could end up weighing you down more like a boulder.