Should You Invest, or Pay Off Debt?

When it comes to paying down debt, the mindset of “the faster, the better” often takes over. But what about preparing for your future? In order to reach long-term investment goals, and reap the benefits of long-term compounding interest on those investments, you need to allocate a dedicated amount of funds each month. So, if you have any amount of debt, you may have asked yourself, “should I pay off my debt, or invest my extra cash each month?”

The answer really depends on your personal preferences and financial goals. Read on to weigh the pros and cons of each to help determine a strategy that makes the most sense for you. 

Pay Off Debt

When What it makes sense to invest vs. pay off lower interest debts in full, like your mortgage, the opposite is true for credit card debt. Take an audit of your debt, including every interest rate and late or minimum payment fees, and determine how long it will take you to pay it off. 

If you have high-interest (14% – 24%) credit card payments due each month, it makes more sense to put any extra cash toward paying that off before investing, since you’ll just be accumulating interest payments otherwise.

It’s also worth considering your risk tolerance. Investments are risky, and do not have guaranteed returns, meaning if you’re uncomfortable with losing cash before investments grow, you should put your money toward paying off your debt, which has tangible rewards. 

Invest 

In general, if you have the opportunity to earn more interest than your debts are costing you, then it makes sense to invest. As Investopedia explains, for example, “if you have a mortgage with an interest rate of 5% and a stock market index fund that is returning 10% a year, you’ll come out ahead by investing your extra cash in the index fund.”

Additionally, if If your debt has a low interest rate (like a student loan or mortgage), continue making regular monthly payments, but keep in mind that some interest, like a mortgage, can be tax deductible. That means there could be some advantages to paying back that debt more slowly, while the interest you earn from an investment could be higher, putting more cash in your pocket in the long run.

It’s also worth considering investing in your future first if your employer offers a 401(k) matching program. By taking advantage of their savings match, you’re funding your retirement for a lot less than you would without a match, essentially investing in your future at a much lower rate. 

Choose Both (if you can)

In an ideal world, you should be working toward paying off your debt while investing in your future finances. 

While that may seem impossible at first, Linda Davis Taylor, former CEO of Clifford Swan Investment Counselors in Pasadena, California, recommends that you separate your finances into three buckets – debt payoff, retirement, and an emergency fund. Even if that means some weeks you can only contribute $10 toward future investments each paycheck, it’s worth starting and building upon.   

No matter where you choose to allocate your extra funds to each month, remember that, without a financial plan in place, your goals will be that much harder to achieve. Set a solid  budget and debt-payoff plan aligned to your personal preferences and strategies, and consider consulting with a financial or retirement advisor to ensure you’re on the right track to reach your short and long-term financial goals. 

LEGAL DISCLAIMER

The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, we advise you to consult with a licensed advisor.