Good morning! Today we have a special guest to the site, Greg from Club Thrifty, who talks about the pros and cons of investing vs paying down debt. It’s a question I’ve often pondered and I can see value to both sides of the argument. Check out Greg’s post below and when you’re done be sure to leave a comment sharing your own opinion.
Should you invest or pay off debt first?
Is it really an either/or situation?
Trust me, you’re not the first person to wonder.
Obviously, if you have debt you’re obligated to pay something on them until they’re gone. You can’t just ignore the debt and go crazy investing.
But, do you pay them off lightning-fast, ignoring investments for the future? Or do you make minimum payments and use the rest for investing?
What is your best course of action?
First, you’ve got to get organized so you know where you stand.
To get started, all you really need is a paper and pen, but a good personal finance software program can help you do this as well. From there, you’ll want to get familiar with your income and spending so you can spot any changes you may need to make.
Once you’ve got a good understanding of your current financial situation, it’s a lot easier to determine the right way to proceed. Here are some things to think about before deciding whether to attack your debt or investments first.
Pros of Paying Down Debt First
You Have a Laser Focus
Waiting to invest until you’re debt-free works for people who need to focus on a single thing at a time.
Many of us just end up frustrated when we try to accomplish too many things at once.
Trying to pay down debt, save for college, save for retirement, and pay off a house all at once can spread your funds too thin. We often find ourselves spinning in too many directions.
By aiming at so many different targets, it’s hard to tell if we even hit one of them!
Several financial experts would tell you that debt needs to be your primary focus until it’s gone. I tend to lean that way as well, but not always.
The fact is that most of us are not really that great at multitasking, and it’s no different when it comes to your finances.
Focus on the debt and bid it goodbye!
It Provides Motivation
If you know you’re throwing away investment returns by focusing solely on debt, you’re probably gonna be a little perturbed with yourself. Let the frustration over missed potential help fuel your drive.
Use that frustration as motivation to take on extra jobs, start a side hustle, skip dining out, and put off unnecessary luxuries for the sake of getting out of debt.
Pain can be a great motivator to make changes quickly.
You’ll Pay off Debt Faster
When you put all of your energy and resources toward paying off debt, you see results much faster. It takes longer (and costs more in interest) when you try to do everything at once.
Debt Affects Your Net Worth
While retirement is important, keep in mind that every dollar you owe reduces your net worth.
By getting rid of debt as quickly as possible, you are that much closer to building real wealth. When you leave that debt hanging around your neck, you’re just postponing the inevitable – having to pay it off.
Pros of Investing While Still in Debt
There are a lot of reasons to keep your focus squarely on your debt. Still, many people choose a balanced approach to debt repayment and investing. Here are some reasons you should consider it.
Investment Returns May Beat Interest Rates
Since your debts likely carry different interest rates, certain debts may be “better” than others. If some loans have a nice low interest rate, it may make sense to do some investing while also paying off debt.
The rate of return on your investments may bring in more than what you’d lose in interest. In that case, you’re getting further ahead – provided, of course, you’re actually using your extra money to invest and not rack up more debt.
Take Advantage of Company Retirement Matches
Many employers offer a free match on a percentage of your contributions to a work-sponsored retirement account. Maybe your boss matches up to 4% of whatever you sock away in your 401(k).
That’s a pretty sweet deal! You’re basically getting free money as a reward for saving!
If you have a work-sponsored retirement account, you should strongly consider saving enough to at least meet the match.
Investments Can Help Pay Off Debt
It sounds a bit backwards, but what if you could make an investment that might bring you more income in the present? Perhaps you’ve found some great ideas for making residual income.
Or, maybe spending a little on personal development could increase your earning potential from a side hustle.
That additional income could be put straight towards paying off your debt, speeding you along the way to debt freedom.
The Safe Path is Also Risky
Obviously, investments are never a “sure” thing. That’s one reason some say it’s risky to invest while you’re in debt.
Don’t get me wrong – debt carries risk too.
But heck, it’s also risky to hide your money under your mattress; it might all still be there in 20 years, but it won’t be worth nearly as much by then!
So if you choose to invest, do so wisely. Investing can be a great source of income for both your present and your future.
Pay Off Debt or Invest: Questions to Ask
Here are a few simple questions you should ask to help simplify your decision:
- Is the interest rate on my debt higher than the rate of return on my potential investments? For example, an interest rate of 18% on your credit card is costing you a lot of money and won’t balance out a 10% stock market gain.
- Is any of the interest on my debt tax-deductible? Student loan interest, for instance, is typically tax-deductible, meaning you get a lower tax bill.
- Is there significant potential for income growth through investment?
- What is my risk tolerance and time horizon? Be sure to consider your age, income, potential for income growth, retirement needs, and more.
The Bottom Line
So, should you pay off debt before you invest?
The real question is this: “What is the right move for YOU?”
Take an honest look at your personal situation, consider what you feel comfortable with, and decide from there.
Whether you invest, pay down debt, or do some combination of the two, it’s really a personal choice. Consider all your options before determining which strategy will work the best for you!
Greg Johnson is a personal finance and frugal travel expert who leveraged his online business to quit his 9-5 job, spend more time with his family, and travel the world. He is the co-owner of the popular blog Club Thrifty, where he teaches others how to spend less and travel more.