Ahhh, the age-old question: should you pay off your debt first or invest first? This is an often discussed topic in the personal finance community, and today I want to unpack what I think you should consider when asking yourself this question.
Here are six things to check before considering investing to pay off debt.
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1.Does your company fit together?
When it comes to 401k matching, I completely disagree with Dave Ramsey. If you are fortunate enough to work for a company that offers employee matching up to a certain percentage, you should take advantage of that match. It's literally free money in your retirement account.
Typically, a company will match your contributions to 4-6%. This is a great way to benefit from growing your retirement investment... and it's free.
For example:
You have a salary of $50,000. If you contribute 6% of your salary, you will have $3,000 in the plan after the first year. If your employer matches 100%, you get $6,000 in the plan. If her employer matches 50% (or 3% of the employee's salary), she gets $4,500 into the plan.
So it makes sense to get that matching into your 401k account even as you pay off debt.
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2.Do you want to pay more on your mortgage?
A common way to achieve financial freedom is to pay off your house early. While I commend those who have the determination and courage to complete this, I don't think it is the only way.
Paying off your house is a big, sturdy security blanket. You do not have a mortgage, you do not have a mortgage on your home, so the bank can never take your home away. It becomes much easier to make financial decisions if you don't have a house note.
What are your goals?
• Do you currently have a side business that you want to run full-time, but that is not possible because of the security you need from your job to be able to pay your mortgage?
• Could you possibly quit your job if you didn't have a mortgage and grow your passion project into something big?
• Or could your partner possibly quit his job?
On the other hand, as with everything in personal finance, there are opportunity costs to consider.
If you pay off your mortgage for years, you are missing out on years of investments. This is where it comes down to personal preference and everyone will consider what is best for them. Remember: personal finance is personal.
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3.Are you risk averse or risk averse?
Investment returns are never guaranteed. Do you know what it is? Your fault.
When you pay off debt, you automatically see a return on that choice.
Sticking to paying off debt is the safest path. That doesn't mean it's "less than" or that you're "doing it wrong" if you decide to go that route. It's just the risk-averse option.
If you're a risk-taker and think you can get more out of your money by buying stocks and playing the stock market game, investing instead of paying down debt might be for you.
4.How old are you?
Age plays a major role in investing. If I were in my 50s and retiring within the next ten to twenty years, I would be more concerned about my retirement and what there will be for me to live on.
Looking back, I wish I had put $200-$300 a month into investments when I was paying off debt. The reality is that age is increasing, despite our best efforts to delay it, and retirement should be a critical part of your personal financial plan and strategy.
If I had invested $200-300 while paying off my debts, my net worth would have advanced much more than it does today, I would have more peace of mind, and I would still have paid off my loans early.
My point is that the older you get, the riskier it is not to invest. Focusing solely on paying off debt is all the more risky because, as we said before, opportunity costs come into play.
It doesn't have to be an all or nothing strategy. You can invest and pay off debt, but remember that your age matters.
5.What does your interest look like?
The average return on investment in the long term is 7%. Consider paying off all debts with an interest rate higher than 7% and then paying minimum requirements for the rest and investing.
That is, if you have credit cards with an average of15-23% april, remove them from your life first. The same goes for student loans at around 7% APR.
6.Do you have an emergency fund?
Regardless of which side you are on, I personally believe that you should have a solid emergency fund of at least 1 month's worth of expenses before you start investing or paying off debt.
Once you have saved for one month, you can build this up to 6 months or even a whole year. It's a lot easier to throw money at loans or retirement accounts when you know you have a stack of cash when you need it.
I'm not going to tell you which side is right or which side is wrong. My goal is to make you think and ask yourself questions.
Comment below, which page do you end up on?
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