At one time you notice that you have extra cash, maybe at the end of the month, it can be a tough decision whether to pay off (or pay down) your debts or to invest in some new stocks.
A lot of good financial decisions don’t make much financial sense. You can crunch the numbers all you want but they’re just not going to add up.
For example, buying a home versus renting. The actual return on home ownership is lower than what you could get investing but it’s still one of the best financial decisions you can make.
Buying a home is a forced savings plan and a consistent return, something than many people sorely need. So, the decision is a good one even if the numbers don’t always work out.
Another hotly debated financial topic is whether you should work to pay off your debt before getting started investing.
Paying off your debt means reduced stress, lower risks, and a greater ability to withstand personal emergencies, recessions, and depressions. Investing means building a reserve that can protect you and your family, provide you with passive income, and allow you to retire comfortably.
How do we go about determining which is the right choice to make and is it always the same choice?
Either Decision is as important to your financial health so let’s find out which is better, investing, or paying off debt?
Paying Off Debt
Most people have found themselves saddling some form of debt or another in their lives.
This can be a mortgage, a student loan, car payments, credit cards, or payday loans.
Sometimes you get unexpected expenses and you have to pay off a medical bill or a vehicle repair.
The reason we take on debt is that we don’t have the money we need readily available so we must borrow from our future income to pay for what we need.
It’s easy to lose track of all your debt and find yourself overwhelmed by how you owe in total.
Keep in mind that not all debts are the same and the way you can determine this is by their interest and if the interest on those loans is tax-deductible.
For example, home loans and student loans aren’t as burdensome because you are able to write the interest off as a tax deduction.
Now if you have debt in the form of a high-interest credit card, Mobile App Loan that you might have an APR of 28%
…And If you thought that sound extremely high, the average payday loan APR is 398%
Never ever use a payday loan unless it’s a life or death emergency.
To put these interest rates in perspective, the average investor makes a return on their money of about 7% every year.
Imagine they made 398% every month. They’d be unbelievably rich in a couple of years no matter what amount they started with.
But when you take out a payday loan, this is what you are giving away.
Almost 4 times what you borrowed.
So you can see why it’s so important to pay off debt as soon as you can, it’s a negative force on your money that multiples every month to an unmanageable degree.
Avoid debt altogether by having a good amount of money saved up (at least $1000) and always pay with cash. If you want something, save for it.
When you invest your money, you are buying assets that essentially cause your money to make more money.
This is done by investing in stocks, bonds, real estate, among various other forms of securities.
The purpose behind investing is to give yourself an income that grows over time.
If you invest for a long time, you could easily find yourself becoming a millionaire or even a billionaire depending on how much is invested.
It’s always better to start early as the earlier you start, the longer your money can compound on itself.
You can start with as little as $100 and you can even start as a minor, with the help of a parent.
So What Should You Do First, Pay Down Debt Or Invest?
Okay so the way to determine this, figure out the interest rate on both these figures
Would you have a higher interest rate on your investments or a higher interest rate on your loans?
Take all your debts and determine how much interest you are paying in total.
Take all your investments and find out what your returns are in total.
Are you losing more money every month than you are earning in returns?
Pay down debt.
Are you earning more money in returns than losing through debt? A lot of people are never going to completely pay off all their debt, even with great tools like this debt payoff calculator. Many others will pay it off but it will take decades to accomplish.
That may sound like giving up on being financially responsible. I’m not saying you should stop paying off debt or stop trying to pay it off as quickly as possible, I’m just trying to be realistic here.
But everyone; you, me, and even the Millennials are all going to retire someday. That means we all need to be putting some gold aside for those golden years.
Getting started investing now, even if you’re still paying down debt, brings two very big benefits.
First, it gets you into the habit of saving and investing.
Paying off debt has its own built-in motivator. You have to make minimum payments and those pesky interest charges are a strong incentive to pay extra. You might not get that same motivation from saving to invest. It’s tough imagining what life will be like 30-years into the future after you’ve worked to build your retirement portfolio.
Now, this isn’t to say you are all in on one or the other, you should be paying down debt and investing in both situations.
It’s the ratio that you are playing with.
If investing is more beneficial, then do a 70/30 split between investing and debt, respectively.
If paying down your debt is more beneficial, then do the opposite.
Get started investing, even if it’s just $50 a month. Getting in the habit of putting something in an investment account will make it easier to put more money in when you are able.
The second reason to start investing before you pay off debt is that you’ll earn money on your money
Even that $50 a month can grow to $71,500 over three decades on the blended market return. Trying to pay off debt first means you might not get around to investing until well into your 40s or later. Building to that $71,500 by the time you reach 65 means depositing nearly $210 a month if you don’t get started until 50 years old.
And there’s always something else to spend the money on, right? Vacations, tuition, unexpected medical bills…there will always be something competing for the money which could be going to retirement investing.
You should still try paying down your debt balances, especially the ones with rates of 10% or higher, but balance it with investing. This especially means credit cards because they are the worst type of debt. Check out this credit card payoff calculator to see what I mean and how much money you’re losing to interest.
Debt is an uncomfortable burden on your finances that feel like a snake continuously constricting your wallet every month, on the other hand not many things feel as great as watching your money grow through investments.
Ultimately it’s up to you whether you love the fulfillment that comes through investing or if you want to rid yourself of the psychological stress that is being in debt.
Now even if you never fully pay down your debt, your investments will grow and someday you’ll be able to make one big payment to ditch your debt forever and still have something left for those sandy beaches.
Investing before you pay off debt may not make financial sense if you look at the numbers but it’s one of the best financial decisions you can make. Getting started investing will get you in the habit of saving and you’ll make money on your money for decades. It’s the best way to get to your financial destination with more than just a few paid bills