Should you pay off debt or invest? This is a common question I receive, and it is a difficult one to answer because every situation is different.
You may have students loans, a mortgage, car loans, credit card debt, furniture debt, medical loans, or something else. Whatever your debt may be, I’m sure you are, hopefully, thinking about your debt payoff plan.
Paying off your debt is a great thing to think about. However, where does investing come in to your overall financial plan? Paying off debt may take what feels like forever, so you may not want to completely ignore saving for retirement and investing while you pay off your debt.
And, this becomes the really tough decision to figure out – should you pay off debt or invest? Should you do both at the same time? Maybe one slightly more than the other?
If you’ve read How I Paid Off $40,000 In Student Loans in 7 Months, then you know that I paid off my student loans quite quickly. In order to do this, though, I had to decide whether to focus on my students loans and pay off debt, or invest in my long term savings and retirement plan.
It was an incredibly tough decision to make, but I made paying off my debt my sole focus.
Deciding to pay off my debt quickly and putting exactly $0 towards my retirement and investing did not sit well with about 50% of you readers.
But, that’s personal finance – it’s personal!
If you are asking yourself whether to pay off debt or invest, I can’t give you a definitive answer because everyone’s situation is so different. However, I am going to go over what factors you will want to think about for your specific situation so that you can make your own best decision.
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So, should you pay off debt or invest?
Do you have an emergency fund?
To start off, I want to talk about emergency funds. So many people wonder if they should have an emergency fund while they are paying off their debt.
I am a big fan of emergency funds. If you have debt and are pondering today’s question, for the most part, I think you should probably still have an emergency fund.
Now, I know that some of you may want to fight me over this, but my reason for still having an emergency fund is that you just never know when you will have an emergency. It’s just that simple. While you’re paying off debt, your emergency fund doesn’t have to be the huge six months (or whatever number) of expenses.
I recommend having an emergency fund of at least $1,000 for while you’re paying off debt. This is a good amount to have because you will have at least a small cushion to help you in case an expense comes up and surprises you.
If you had $0 in your emergency fund versus a small one of at least $1,000, that can make all the difference in really being able to focus on debt repayment as you will be less likely to add to that debt during your repayment period. What if you had a medical emergency, immediate home or car repair, and more?
If you didn’t have an emergency fund but had debt, then this could make for a disastrous situation. Without an emergency fund, it’s likely that you would have to add to your debt, and it would most likely be at a higher interest rate because you would probably have to use a credit card.
Related content: Everything You Need To Know About Emergency Funds
How fast do you want to get rid of your debt?
For me, I put 100% of what I had towards debt and 0% towards investing. I chose this option because I just wanted my student loans to be completely gone. That huge monthly payment felt like such a big weight hanging over my head, and I just wanted to stop worrying about it.
If you hate debt as much as I hated my student loans, then this may be the option for you as well.
Some people, like myself, get stressed out by debt, or certain types of debt, which can then impact other areas of their lives. If having debt is leading to extra stress, which can lead to health issues, impact your relationships, work, etc. then focusing as much energy as possible on debt repayment might be the best option for you.
By eliminating your debt, you are then free to focus on improving other areas of your financial situation, such as investing for your future. This is almost like choosing to single task versus multitask – you put all of your energy into one thing so you can focus on doing it efficiently and well, and once you are finished with that, you can put all of your energy into your next goal.
What’s your interest rate?
Now, there’s a chance that you may not really mind debt. Debt doesn’t have to be the end of the world, and many people are able to use debt to their advantage. That might sound crazy, but it can be done!
If you have a low interest rate, then this may be something that you are thinking about – investing more instead of throwing everything towards your debt.
I still remember my finance and economics professor in college talking to me about his student loans. He still had them and wasn’t worried about paying them off quickly at all, because the interest rates were 2% or less. So, instead, he put as much money towards investing because he figured he could beat his interest rate by investing in the stock market and in other areas of his life.
However, if your interest rate is high, then you may want to pay it off more quickly. For example, credit card debt may have an interest rate of around 20%. There are also high interest rate student loans (such as with private student loans), crazy expensive leases (such as on furniture), and more. These are the types of debt that you will really want to focus on because as that interest adds up, you ended up paying exponentially more in the long run.
If you think your interest rate is high, then you will probably want to think about getting rid of your debt quicker, because the interest is just going to keep piling up until it just seems so unmanageable, and this can make your long term investing goals seem impossible to reach.
Personally, I think that if your interest rate is around 6-8% or higher, then you may want to think about paying off that debt a little quicker so that the interest charges don’t build up too high.
Do you get a company match?
If your company provides a 401(k) match, then this is a benefit that you will most likely want to accept as you decide to pay off debt or invest. If your company matches your 401(k) contribution, they are giving you money, for free. Even if you add a little in, you can still take advantage of their contribution.
If you don’t take it, then you are leaving a valuable benefit on the table, one that you have earned by working. It’s not like you would just let the company keep a paycheck of yours, so you should most likely treat a company match similarly!
While I realize that choosing to pay off debt or invest can be an incredibly hard decision to make, you should know that you are on a good path either way. Having the option to choose between paying off debt and/or investing will bring you closer to achieving your financial goals, and the fact that you are doing one or the other means you are making a positive decision for your future.
This is really important when deciding which to focus on – both choices are good. If you are just absolutely stuck, then you may want to put half towards your debt and half towards your investments, so that you can move on with life and spend more time improving your finances in other areas.
Also, remember that personal finance is personal. What may have been a great decision for one person may not be the greatest for another. You will want to weigh your options and see what is best for your specific situation.
What would be your choice? Should you pay off debt or invest? A healthy balance of the two?