Life is all about big decisions.
Picking the right partner, career, and where to live are difficult enough. When your choices involve money, there is even more to consider. Should you pay off debt or invest?
Here’s how to figure out which decision is best for you.
- Get comfortable with your budget. Build an emergency fund — at least $1,000 to start — with a long-term goal of three to six months of living expenses.
- Don’t skip your employer’s 401(k) or 403(b) match.
- Tackle your high-interest debt first.
- Compare your expected rate of return for investing vs. your debt’s interest rate(s) — after any tax deductions — to prioritize what’s next.
- Consider your feelings and risk tolerance before making a decision.
Start with your budget
It’s not easy to juggle basic expenses like rent, utilities, transportation, and groceries. If you are paying for these with ease — and have money left over — congrats! The next step is deciding how to spend your extra cash.
Small splurges are healthy, but too many could hinder your financial goals.
If you are itching to pay off debt, invest, or both, budgeting is essential. Take the time to track exactly how much money is coming in vs. going out.
Save an emergency fund
Before funneling cash into debt or investments, you need at least a small emergency fund. This is your stash for costly, unexpected expenses. Car repairs, medical bills, and broken cell phones are part of life.
By setting money aside — even $1,000 or $2,000 to start — it’s less likely these curveballs will increase your debt.
If you have high-interest debt, you may consider a slightly lower number — at least until your most expensive debt is gone. Aim for a long-term goal of three to six months of expenses.
Don’t skip your company’s retirement plan matches
Before diving into a new debt payoff or investing strategy, review your company’s retirement plan.
Many companies offer to match a percentage of your 401(k) or 403(b) contributions (free money!)
Skipping this perk is like giving up part of your salary. Try to lock this in while you focus on your other goals.
Pay off high-interest debt before investing
If you are paying off debt, you are far from alone.
Most Americans have it — including mortgages, student loans, credit cards, car notes, and more.
The problem is, not all debt is equal.
There’s a big difference between your 5.05% federal student loan and 16.99% to 23.91% credit card debt.
High-interest credit card debt costs more over time, making it more difficult to pay off. By tackling it first, you could save hundreds or even thousands in interest.
Best of all, it may free up cash to beef up your emergency fund or kickstart your investing plan.
Why investing matters
Before diving into the specifics, it’s helpful to understand the basics of investing.
While investing for the long-term involves increased growth potential, it also comes with increased risk. When you invest in equities for example, your money can grow through dividends to shareholders or if the equities you are holding increase in price.
Three ways you can harness the power of the long-term for your portfolio are invest early, reinvest your earnings, and stay diversified.
The problem is, younger folks are less likely to invest than their parents.
This means missing out on years of building wealth. According to a recent Gallup poll, only 37% of folks under 35 currently invest in the stock market — down from 52% before the 2008 crash. It’s normal to fear the stock market. After all, no one can predict what the future will look like.
Skipping investing early in your career is a mistake.
You may not have a company pension or Social Security to fall back on. It may take 10, 20 or 30 years before you are debt free. In most cases, this is too long to wait to start investing. By then, it may be too late to catch up.
When to invest before paying off debt
Paying off credit card debt first may seem like a no-brainer, but other debts need a closer look.
To choose between paying off debt vs. investing, you have to review the numbers. You should compare your expected investing return vs. how much interest you are paying.
Often, you need to consider taxes too.
Some types of interest — like student loans or your mortgage — may offer a tax incentive, depending on your income. These are more confusing, so don’t be afraid to ask a tax professional for guidance.
If you decide to invest vs. pay off debt sooner, you still have to make on-time minimum monthly payments. Otherwise, you may hurt your credit score and have higher interest rates for years to come.
Pay off debt or invest? Your feelings matter, too.
If you’re a numbers person, it’s easy to see the power of investing.
Small, regular contributions may grow more than you expect. By crunching the numbers, it’s easy to see whether paying off debt or investing is the smarter choice. Paying off low-interest debt sooner may not be best — especially if you expect to earn more elsewhere.
But math doesn’t factor in your feelings or personal risk tolerance.
Debt often causes a lot of stress. If the weight keeps you awake at night, there is nothing wrong with paying it down sooner.
You can’t put a price tag on your peace of mind. The decision is yours.