Should you pay off debt or invest? Based on your financial situation, what would be the better option for you? What should you consider to arrive at the best decision?
This is a common question, yet it is extremely difficult to answer. There is no straightforward answer because there are certain factors you need to understand. Every situation is different, and every person has different preferences, responsibilities, and goals in their lives.
Besides that, everyone has a different kind of debt. You might have a mortgage, student loans, a car loan, credit card debt, or something completely different. Whatever kind of debt you have, you’ve been most likely been thinking about a debt payoff plan.
Paying off debt might be the most important thing for you right now. But where does investing fit in your plan? How do you budget your money between paying off debt and investing your income to earn more money?
Paying off debt can feel like it takes forever, so it should be in your best interest not to ignore your retirement savings and investments completely.
This is a question that you should face and ask yourself – should you pay off debt or invest? Should you try to do both? Or could you opt for one slightly more than the other?
So many options! Let’s dive into it and see what fits best with your situation.
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Begin With Your Budget
Having a budget can be exhausting, especially if you are following a strict budget. If you have extra cash left, you have extra money to either pay down debt or look for ways to increase your savings.
But if you want to pay off debt or invest, you need to start with your budget. Creating a budget that works for you is very important, especially if you want to save more to reach your financial goals. In addition, you would be able to track your expenses and know where your money is going without feeling like you’re missing out on the things you love.
It is okay to go over budget at times, just don’t make it a habit. Sometimes living a frugal life can be your way to reach your financial goal faster. It’s just a matter of prioritizing which matters most.
[Related Read: 20 Essential Frugal Living Tips]
Should You Pay Off Debt Or Invest?
To answer this question, we’re going to discuss a series of key questions with you.
If you’re deciding whether you should pay off debt or invest, take this into account:
- What is the current interest rate of your debt?
- How eager are you to get rid of your debt?
- Do you have a sufficient emergency fund?
- How much is time left until your retirement?
- Personal finance is personal
What Is Your Current Interest Rate On Your Debt?
The first thing that can really influence your decision to pay off debt or invest is how high your interest rate is.
If you have a low-interest rate on your debt, this may be something to think about – investing more instead of trying to pay off your debt as soon as possible.
That is the case for me personally. I have a 0% interest rate on my student loans, which means that I should get a higher return in the stock market (which gives, on average, a 7% return). I am not going to pay off my student loans quickly. Instead, I invest the majority of the money by investing in low-cost index funds.
If your interest rate is high, you probably want to pay off your debt quicker. With a high-interest rate, it will just keep piling up. If there’s something we don’t want, is your debt to seem unmanageable – this can make your investing goals seem hard to reach.
If your interest rate is higher than 7%, you may want to think about paying off debt quicker. Why? Because the average rate of return of the stock market is exactly 7%.
If your interest rate is lower than 7%, read further to decide what you feel most comfortable with!
How Eager Are You To Get Rid Of Your Debt?
Personally, I put 100% towards investing and 0% towards debt at this moment. I chose this option because the interest rate is so low. I feel zero pressure to pay off my student loans because I know my money will make me more money when investing in the stock market.
This is again a personal decision.
If you’re not bothered by the debt at all, and you’re comfortable with having debt, that’s okay! As long as your debt and spending won’t get out of hand, it will be fine.
If you hate debt and want it to be gone entirely, paying off your debt quickly may be the way to go.
I know people who get very stressed out by debt, even specific types of debt. If you’re stressed out, this might affect other areas of your life. When you’re stressed out about having debt, this can impact your health, work, or relationships.
If having debt makes you stressed out, putting as much as you can towards your debt will make your life much lighter.
By paying off your debt, you will get more energy to focus on improving other parts of your financial life. You can choose to start investing your first dollar. You can decide to start investing in Peer-to-Peer lending or work towards different financial goals.
Do You Have An Emergency Fund?
Once you have decided whether or not debt stresses you out, let’s get into another important aspect: emergency funds.
Many people are wondering if they should have an emergency fund while paying off their debt.
Let me tell you this: whether or not you’re paying off debt, you should have an emergency fund. You simply never know when you will have an emergency.
When you’re not paying off debt, I recommend an emergency fund of between 3-6 months of living expenses. I know that it can be hard to attain this amount of money when paying off debt, so it doesn’t need to be that big.
I recommend you have an emergency fund of around $3000 while you’re paying off your debt. This will make sure you have a small cushion in case any surprise expenses come up.
Imagine if you have $0 in your emergency fund, you will need to go into debt immediately when an expense comes up. When you have an emergency fund of around $3000, you can stay focused on your debt repayment plan instead of adding debt during your repayment period.
What if you had a car emergency, home repair, or medical issues?
If you don’t have an emergency fund, this could lead to getting into more debt – which is exactly what you want to avoid. When you’re getting into more debt, it would most likely be at a higher interest rate because you will probably use a credit card.
You don’t want to be in a situation like that. Start building your emergency fund now, and you’ll be fine!
How Much Is Time Left Until Your Retirement?
Another thing to factor in whether to pay off debt or invest is the time until (early) retirement.
When you retire while you are still in debt, this may affect your retirement life. This is again a personal aspect. Some would be totally okay with still paying a mortgage, while others would not want to be bound by monthly payment after monthly payment.
That is why as early as now, you should probably be prioritizing how to reach that financial freedom and eventually retire early. If you think that you are still far from your financial goal, look for ways to earn extra income through side hustles and build your wealth.
[Related Read: The Rule Of 25 To Know How Much You Need For Retirement]
Personal Finance Is Personal
One very important thing to remember: personal finance is personal.
Choosing whether you’re going to pay off debt or invest can be a hard decision. Just know that you’re on a good path whatever you decide.
You have the option to choose between paying off debt or investing, which will make sure you get closer to reaching your financial goals!
If you’re choosing one of the two or doing both, you’re moving forward and making a positive impact on your financial future.
While it is important to decide which you want to focus on, both options are good. If you are not sure about what is best in your situation, try to put half towards your debt and half towards your investments.
Remember: personal finance is personal.
What is great for you may not be great for someone else.
Consider the options that you have and decide what is best for you in your specific situation!
Frequently Asked Questions – Pay Off Debt Or Invest
Pay off debt or invest? This question can get many answers as this is a very personal decision. Again, the answer to this question depends on an individual’s financial situation. However, some frequently asked questions may help you in your decision.
Is It Better To Pay Off Debt Or Invest?
Paying off your debt and investing are both excellent things to do. If you have some extra money and can earn more in your investments, you may do so rather than paying off debts that would historically not give the same 7% yearly returns.
By investing, you have the opportunity to earn more money to either pay off your debts after or to add to your savings. These additional savings will help you achieve financial freedom and retire early.
But if you want to concentrate on paying off your debt first rather than putting your money in investments, then you should do so. Do what you feel is important.
Being debt-free first is a safe and sound argument to no longer worry about your debt.
Should You Stop Investing To Pay Off Debt?
If your budget does not allow you to invest, you can hold off on investing and concentrate on paying off your creditors. Investments may be risky, especially if you live paycheck to paycheck. The general rule is not to invest the money you need within 5-10 years.
Check your income to know if you have some wiggle room to make investments because if you run a tight and strict budget plan, adding investments may not be beneficial for you in the long run.
Can Investing Put You In Debt?
Investments can earn you more money for your current and future needs. But you need to understand that investing carries with it a risk that you may partially lose money.
That is why it is recommended only to invest what you can afford to lose. Know what your budget permits you to invest so that the money you put in investments is money that you will not use in the short term.
Conclusion – Pay Off Debt Or Invest
Paying your financial obligations is a responsibility you cannot run away from. Investing money is an important aspect you should consider to reach your ultimate goal of financial freedom.
So for you to know to pay off debt or invest, you need to know first what you want in life and where you are in your life.
Both options present their own pros and cons and what is variable here is you. What do you want to achieve in your life, and what can you do to reach these goals?
You cannot force yourself to invest if you cannot afford to, and you cannot pay off debt if you are not in the position to do so. So sit down, and ask yourself this: What can I do with what I have now?