Tough Times Series: Gen X: Ditch Your Debt and Become Smart Savers

Despite the recent rollercoaster ride on Wall Street, Jason and Beth Roach are on track to retire in 10 or 15 years. They have nearly a year of emergency funds ready in cash and bonds. They have more than 50% equity in their $400,000 home near Portland, Ore. They have substantial savings in their children's college funds. They sound like sure-footed boomers who somehow sidestepped the worst of the current economic crisis. But they aren't. Beth is 35. Jason is 36. These two stand solidly in Generation X.

Beth recognizes that most of her peers don't have such sure financial footing. "Many of my friends have credit card debt and can't seem to make progress saving," she says.

Indeed, more than two-thirds of Gen X members have credit card debt, according to a 2008 study of Generation X and Generation Y by the American Savings Education Council, Washington, D.C. And a whopping 86 % have some other kind of debt in the form of car loans, student loans, medical debts, and home equity lines of credit.

Gen Xers lax about debt

Most of those Gen Xers aren't bothered by their debts. Take Stewart Erlich. The English instructor at Front Range Community College outside Denver doesn't have a whole lot in savings. He's counting on his defined benefit plan, a rarity these days, and he doesn't have an IRA (individual retirement account) or other retirement account. He has about $1,000 in the bank for emergencies. Plus he has a mortgage, student loans, and credit card debt. He knows he needs to better manage his debt, so he and his wife Kara took in a housemate to help pay down the credit card balance. The recent birth of his daughter has him thinking a little more critically about his finances.

"I can't give you a very solid picture of my financial situation. I don't have a handle on it. I have a general sense of how much I have in the bank and how much I owe," Erlich says. "I'm only now starting to come into awareness of how much needs to change over the next few years ... but I feel that it's within my ability."

Financial planner Rebecca Schreiber, Washington, D.C., says there are a lot of Gen Xers in that same position: heavy on debt, light on worry. So she founded Solid Ground Financial Planning, Silver Spring, Md., to help those Gen X individuals and couples who know they need to do a better job managing debt and savings but who aren't sure where to begin. "They are smart enough, savvy enough, and earning enough to make financial decisions," she says.

The problem isn't that things are desperate and that fiscal health is out of reach. The problem, rather, is that they have "taken on a lot of debt and they've done it rather quickly," Schreiber says.

So what is the difference between a lot of debt and too much debt? Specifically, says Susanna de Baca, a financial and investment adviser in Des Moines, Iowa, a debt-to-income ratio (total monthly debt payments divided by total after-tax monthly income) of more than 36% is a good benchmark. If the ratio creeps over 50%, "that's where your debt can really start interfering with your financial health," she says.

Practically speaking, de Baca adds, "If you have so much debt that you can't even think about saving, then you have too much debt." A recent Charles Schwab study revealed that 45% of Gen Xers fit this description.

Schreiber thinks things aren't as dire as the statistics might suggest, and she believes there almost always is room for improvement once a Gen Xer is willing to roll up his or her sleeves and get to work. She says the first step is to take a look at where all the money goes�from rent or mortgage payments to dry-cleaning bills to lattes. She recommends tracking expenses for a few months to get an accurate picture. Even a month of recording receipts really opens eyes. "[Clients] say, 'I had no idea I was spending $800 a month on that,' " she says. "That" could be dining out, entertainment, clothes�any number of things.

Schreiber doesn't ask clients to give up every espresso or to switch to ramen noodles instead of Thai take-out all the time, but she does want her clients to recognize the implications of their decisions. "Make it a conscious choice," she says. "People are panicked and feel like money is slipping through their fingers because they don't know what they're spending and how to stop it."

Budget has benefits

The next step is to create a spending plan. Schreiber breaks expenses down into fixed and variable. Fixed expenses often can be changed, but usually not quickly or easily. These include rent or mortgage and most debt payments. She recommends leaving those alone at first and, instead, attempting to cut variable expenses. Those include entertainment, clothing, meals out, travel, and incidental purchases and services. Simple changes include using a library instead of buying books, cooking for friends instead of meeting out for dinner, laundering dress shirts instead of sending them to a dry cleaner, and driving to nearby vacation spots instead of jetting across the country.

De Baca agrees with Schreiber that the goal should not be to eliminate pleasures altogether. "It's a little bit like a diet," de Baca says. "If you start starving yourself ... you'll put undue strain on yourself and your family, and then the whole plan falls apart. Be realistic."

Both de Baca and Schreiber note that fixed expenses can be changed. Someone always can move to a lower-rent apartment or even renegotiate credit card terms. For example, if you don't already have one, consider switching to a credit union credit card. Credit union credit cards often are cheaper and more consumer-friendly than credit cards from banks and other institutions.

Reduce debt, save

Both experts also agree that it's essential to save while reducing debt. So the first savings step, which ultimately helps stem debt growth, is to establish an emergency fund. Most experts recommend having at least three�often at least six�months of living expenses saved. Schreiber says she ratchets things down a little and encourages clients to have six months of debt payments, rather than total living expenses, in savings. "Debt payments, if you miss even one, will haunt you for seven years on your credit report," she notes.

It often seems counterintuitive to save when debts are lingering or mounting, but Schreiber says that emergency fund is key. Otherwise the next car repair or broken appliance will have you reaching for your credit card�again. And if anything is going to stop you from living within your means, it is your credit cards. De Baca says the only smart way to use credit cards is to pay off the balance every month.

That's what the Roaches do, even if it leaves them with barely $100 in their checkbook. Then they switch to cash for a couple months to get spending back in control. "When you pay for everything in cash, it's harder to let go of the money," Beth says. "We actually spend less on food and everything else."

It makes sense�it's downright madness to pay interest on a cup of coffee or even a tank of gas. And emergency credit card purchases really are no different. Schreiber points out that you wouldn't have to seek shelter with your credit cards at the first sight of clouds (or leaky roof or broken window) if you had a rainy day fund.

After that, both Schreiber and de Baca recommend a dual savings and debt pay-down approach. The most obvious savings opportunity for working Gen Xers is the employer-sponsored 401(k). It's even better when an employer matches contributions. Ten percent of pretax income is the baseline recommendation, and many experts will encourage individuals to invest the maximum allowed. Your payroll department can guide you.

Meanwhile, de Baca says, pay down debt, attacking the highest interest rate first. She notes that debt�just like spending�is emotional and sometimes it makes some sense to tailor the strategy a little. So if you have three credit cards with significant balances, it might make sense to pay one off completely (while making the minimum payments on the others) instead of trying to pay down all three at the same time. "That's totally psychological, but if it works for you, you can move on to the next one," de Baca says.

As individual financial pictures improve, Gen Xers should look for more opportunities to save. An easy way is to find an interest-bearing checking account.

Experts also recommend opening IRAs in addition to a 401(k) or 403(b) to maximize both savings and tax benefits.

Next, get a financial adviser and develop an investment plan. Once you have a plan, do what the Roaches do and have money automatically deducted from paychecks and directed to investments.

Luckily, Generation X has years of earning power left. It isn't too late to start making incremental changes that can have a profound effect now and when it's time to retire. But the sooner the better, says Charles Schwab director of acquisitions Ilkay Can, noting the time value of money works in favor of those who start saving early. "We live a long time. We like to do lots of things," Can says. "We've got to look to the future, set aside money, and let it compound over time."

Published January 20, 2009