There are two guys, Joe and Frank. They both have savings accounts that earn 3% and credit cards with a 15% interest rate.
Joe has no credit card debt and no savings. His situation looks like this:
Savings = $0
Credit card debt = $0
Joe decides “You know, I think I need some money in savings”, and so he borrows $10,000 on his credit card and puts it in his savings account. So now his situation is like this:
Savings = $10,000
Credit card debt = $10,000
You laugh. And well you should. This costs Joe $1,200 a year in interest, the difference between the 3% he earns and the 15% he spends on the credit card debt.
Now Frank has a different problem. He has no savings, but he has $10,000 in credit card debt. Franks situation:
Savings = $0
Credit card debt = $10,000
He knows he needs to pay that debt down. But he says “I know I need to pay off that debt, but if I don’t start saving I’ll never have anything set aside”. So he saves and saves, paying only the minimum on his credit cards. And finally he saves $10,000. His situation now looks like this:
Savings = $10,000
Credit card debt = $10,000
Look back at what Joe did. Now look at Frank. They are in exactly the same situation. They both have $10,000 in savings and $10,000 in credit card debt. What this means is that if someone is saving when they have credit card debt, they are actually borrowing that money from their credit cards, just like Joe did. And it costs (in this case) a not trivial $1,200 a year, just like it did for Joe.
Notice I’m being very clear about this being credit card debt. A low interest car loan, or a home mortgage are very different. Also money put into a 401k plan at work is different, since you’ll earn more than 3% and get an income tax deduction.
We laugh at Joe, but I think we’ve all been Frank from time to time. Keep this in mind when looking at your whole financial picture.