At some point in most individuals’ financial lives, the question of whether paying off debt or saving and investing rears its confusing, sometimes ugly head. The dilemma is complicated by the fact that debt often comes at a price while investing boasts a return on your money that will pay off well into the future. While everyone’s circumstances are different, determining whether to pay off debt or invest for the long-term can be made far simpler by asking yourself the following questions.
Do I Have High-Cost Debt?
The first consideration when thinking about paying off debt versus saving or investing is the cost tradeoff between the two. First, let’s look at the cost of debt. The average interest rate on a credit card is more than 20%, while personal loans carry a much lower interest rate. Over the lifetime of your debt, higher interest rates end up putting a serious dent in your wallet.
Unless you have an investment opportunity that guarantees a higher return on your money than the interest accruing on your debt, your efforts should be focused on paying down your balances first.
Do I Understand How Investments Work?
Investing in the stock market is intriguing given the allure of potentially high returns. However, without a solid understanding of how investments work – both to your benefit and your detriment – you shouldn’t be jumping in with both feet and leaving your debt behind. All investments carry some degree of risk, whether that is comprised of market volatility, shifts in interest rates, or liquidity. These risks should be weighed carefully prior to gambling with your money.
If you haven’t taken the time to gauge your appetite for risk, consider investment options, or think about the need for money you plan to invest, step away from the investing option. You can find a balance between paying off debt and investing, but only after you’ve educated yourself on these important facets of investing.
Do I Have an Emergency Fund?
Building a savings account that is easily accessible is a necessary component of anyone’s financial foundation. An emergency fund, which is typically held in a traditional or online savings account, should represent an amount equal to or more than three to six months of your living expenses. That includes mortgage or rent payments, utilities, groceries, insurance, and for some, retirement plan contributions.
If you have yet to establish an emergency fund, you should forego thinking about investing for the moment. Work on paying off the debts you owe and siphoning off a small amount each pay period to build up a rainy day account so you’re covered when a financial emergency comes up.
Final Thoughts on Paying Debt versus Investing Money
Answering these questions should shed some light on whether you should pay down debt, invest your money, or find a workable balance between the two. If you’re unsure about your options, working with a financial expert can be an invaluable tool in figuring out the balance, even if you’re just starting out down your financial path.
Everyone’s circumstances are different, and so it is important to take into consideration the total cost of your specific debt, your degree of understanding surrounding investments and their risks, and your ability to cover an unexpected bill from savings before jumping onto the investment bandwagon.
