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Should You Invest or Pay Off Your Debt First?

Should You Invest or Pay Off Your Debt First?

| August 25, 2023

Suppose that you have boosted your regular income or come into some quick cash. Rather than splurging on something, you’ve decided to use that cash to take care of business. 

Looking at your financial statements, you see that you have room to invest. But you also see long-time debts on the balance sheet.

What should you put your cash toward — new investments or paying down debt? It’s a good question for anyone with extra money. As you might expect, there are different correct answers. It comes down to the details of your financial profile.

Get Some Affairs in Order First

Financial experts have some very loose rules of thumb about this situation. Each one, however, takes certain assumptions into account. Before considering investing or paying down debt, you should have a few things taken care of:

  • Have your credit card debt entirely paid off
  • Set up an emergency savings account with a bank or investment broker
  • Get clear on your employer’s matching policy on your retirement fund

By dealing with these financial issues first, you’ll set a good baseline for your next financial move.

Investments and Debt Both on the Rise

Investments and debts represent two opposite approaches to time. Making investments in stocks, bonds, and funds is a plan for the future. Managing debt involves taking care of past actions.

One might assume it’s best to clear up past debts before taking on the future. Sometimes it is — but not always. You may find it beneficial to make a few investments while you can. That may be before you’ve paid down all your existing debts.

Debt management is a necessary skill. According to debt.org, household debt in America hit nearly $17 trillion in 2022. At the same time, Americans are gradually ramping up their investment portfolios. Statista says that approximately 58% of Americans invested in stocks in 2022, the highest annual percentage since 2008.

While everyone’s situation is different, financial experts have arrived at a very general yardstick that can help guide your decision.

The 6% Solution

The fundamental answer comes down to interest rates on both your investments and your debt.

Generally, debts that carry high interest rates should be paid off as soon as possible. That’s why it’s recommended to take care of credit card debt before you do anything else. Credit cards usually entail interest rates between 15% and 25%, sometimes more. Paying off credit cards and short-term loan interest will take care of those massive interest rate charges.

Debts that don’t swallow up a lot in interest — mortgages, auto loans, student loans — don’t cause that big of a dent in your wallet. Optimally, you should take care of those debts in regular installments. But in some cases, you may earn more interest on investments than you pay off in your debts.

Experts have set a loose baseline for debt interest rates: 6%. Simply put, if the interest rate on your debt is 6% or more, pay it off first. If it’s under 6%, you might want to think about investing that extra money.

Other Factors to Consider

It must be said that the 6% cutoff is just one of the criteria you should consider. There are other matters, both economic and personal, that you should think about.

Risk Tolerance

If you decide to invest, be prepared. The investment market can be extremely volatile, as we’ve seen in recent years. Decide how much risk you feel comfortable taking on. If your investments make you feel as uneasy as your debt, you might want to wait.

Credit Score

For better or worse, your personal credit score is necessary to watch. Paying down debt makes it higher. But so does responsibly taking on new avenues of credit. If your credit score is very positive, you may have room to invest. If it’s negative, think about fixing it.

Financial Goals

What are your overall financial ambitions? How urgent is it to attain these goals? These are questions that should guide all your economic activity. That goes especially for the question of investment versus debt repayment.

Find the Right Answers with Good Life Financial Advisors

There are no hard-set, right or wrong answers to the decision of investing or paying down debt. There are only solutions that pertain to your personal finances. 

Good Life in Morehead City will give your financial situation diligent consideration. We’ll be up front about what investment strategies will work for you, and we’ll help you manage your past debts to aim toward a better future. To learn more, contact us today.