Deciding between repaying debt repaying versus investing may seem impossible. Everyone’s financial situation is different and only you know from an emotional standpoint what might work best.
Start with your budget. Balancing basic costs such as rent, utilities, transportation, and groceries is a necessary task, so you can understand how much money is going out vs. coming in.
Also, monitor your small spending sprees. Here or there is okay, but if you do it often then that can affect your financial plan.
Just know that all debt is not created equal. Good debt is considered things like a home mortgage and a car loan. Bad debt is things like credit cards, home equity lines, and student loans.
There’s a big difference between paying 2% to 5% on your home loan vs. credit cards, where they range from 14% to 23%, depending on your credit score. High-interest credit card debt costs more over time, making it much more difficult to pay off.
By tackling credit cards first you could save hundreds or even thousands of dollars in interest. However, some people prefer to start with smaller balances. The idea is to eliminate them more quickly and feel more productive.
Furthermore, homes are an investment.
However, expected returns vary widely city-to-city and are highly dependent on a city’s home price-rent ratio. Nonetheless, there is no reason to pay down a mortgage quickly when rates are low and you can use those dollars elsewhere!
If you can earn more return on your money by investing it than the interest your debts are costing you, then it makes sense to invest. However, the biggest thing you want to also understand is that equity market returns in the past five years have outpaced even the most optimistic forecasts.
Historically, the best predictor of long-term returns that we have relied upon has been based on historical valuations and forecasts. Equities usually deliver 5% to 7% market returns, not the 15% to 30% that you have seen over the past few years.
Therefore, if the interest rate on a debt are greater than 6%, you should pay them back.
While investing for the long-term involves increased growth potential, it also comes with increased risk. When you invest in equities (stocks) for example, your money can grow through dividends to shareholders or if the equities you are holding the price increase.
Four ways you can harness the power of long-term investing are to invest early, reinvest your earnings, and stay diversified within and across multiple asset classes and review annually and rebalance your account to make sure they are still in line with your goals and objectives.
Finally, don’t skip your company’s retirement plan matches.
Before diving into a new debt payoff or investing strategy, review your company’s retirement plan. Many companies offer to match a percentage of your 401(k) or 403(b) contributions. That’s free money for you.
Skipping this perk is like giving up part of your salary so you want to be sure to lock this in while you focus on your other goals.
Debt repayment can free up money to add to your savings or provide a boost to your investment plan. Paying down the debt versus investing does not have to be an either/or decision.
You may and should sometimes do both.