Should You Invest or Payoff Credit Card Debt?
vemuda.com - A balanced approach to wealth management serves both today’s needs and tomorrow’s goals. For some, that may mean paying off some debt today while simultaneously investing for the future.
Of course, your own needs and circumstances will be unique. But hopefully, this post can help you evaluate alternatives and find an approach that fits your situation and goals.
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If you have some extra cash flow each month, you might be wondering what the best thing to do with it is: should you pay off debt, or should you instead invest? The answer can be complex, and it varies depending on your financial situation.
So, it’s crucial to consider where you are financially, the rates of return you could expect with each option, and a variety of other factors.
So before you start putting money away toward either option, it’s essential to make sure you have your financial basics covered. And the best way of doing this is to create a budget if you don’t have one already so you can see how your monthly income is spent.
Since your finances are finite. You, therefore, have a limited amount of money to pay down debt, invest and cover your expenses. This is why it’s important to learn what comes in and goes out each month.
If you stick to your budget, you’ll have better control of your personal finances. This will allow you to dedicate as much cash as possible towards each ‘category’, thus increasing your net worth whilst lbuilding a solid financial plan.
Once you determine the amount you’re able to set aside for paying off debt or investing, you’ll need to prioritise your options.
Investing is a way to set money aside for the future in an investment vehicle. Examples of this include bonds, stocks or mutual funds. The great news is that, the value of these vehicles will grow with time.
On the other hand, debt represents money that you’ve spent already and that your lender is charging you interest on. When this debt is left unpaid, it only grows with interest charges adding to your balance and incurring interest charges on their own.
In the case of investing, this is the rule of thumb: if you can earn more interest on your money by investing it than your debts are costing you, then investing makes sense.
Another thing to consider is your risk tolerance. If you are comfortable taking the gamble that your investments will depend on the rise and fall of the markets, then investing is a better option as opposed to someone who’d be restless wondering how the market will be.
When it comes to paying down debt, there are several good arguments for opting to pay down debt rather than investing. For one, your debt carries a relatively high-interest rate. This is especially the case with credit card debt.
Another reason to pay down debt is your credit score, which is important if you’d like to borrow money for a mortgage or get a loan on a car. If you have a low credit score you’re likely to pay higher interest rates (that is if you can get a loan at all).
Your credit score can also affect other areas of your life. Some examples include the premiums you’ll pay for insurance, whether you’ll be able to rent a place, or if an employer will hire you. Paying off debt - especially if you have lots of it - can be the right way to go for that reason alone.
Psychology is also a factor that comes into play. If your debts are making you lose sleep, then you’d rather repay them even if you might get a better return on your money by investing.
When you think about it, paying down debt or investing doesn’t have to be an “either – or” decision. Why not do both? Investing and paying off debt are essential financial goals. Your investments and your debt are elements of your net worth.
While your assets increase your net worth, your debts are dragging it down. Since your focus should be increasing your net worth, you should aim to increase your assets and minimise your debt at the same time.
To do this, commit as much of your cash flow to fulfilling these goals as possible, ideally all of your free cash flow after you factor in your necessary expenses.
If you have high-interest rate credit card debt, focus on paying it off first. If you are investing when you have credit card debt, you are likely paying a higher rate on your debt than you are earning via your investments.
Unless you have a huge amount in investments, you end up losing money overall. Some debts tend to be lower however, such as mortgages and student loans which you don’t need to be as aggressive with those as with high-interest debts.
How to start investing
Investing your money is important to building wealth. But you need to make certain you’re ready before you start using your cash to buy investments. If you have a lot of credit card debt, you may not be in a position to invest much.
When you have a limited amount of money, you have to decide how best to use it to maximise the return on investment it provides.
In most cases, paying off credit card debt is going to provide a better return on investment than just about anything else you could do with the money.
The one exception to this is if your employer provides a 401(k)-matching contribution when you invest in your workplace retirement plan. If your employer matches contributions you make, that’s free money.
The specific return you get will depend on the percentage of contributions the company matches, but it’s common for employers to match 50% or a 100% of contributions up to a certain percentage of your salary.
So, investing enough to earn the full employer match could end up giving you a return on investment of around fifty to a hundred percent.
Investing in your retirement account is often a good place to start. Experts recommend putting at least 15% of your annual income towards your retirement.
Whether you do this through a work-sponsored retirement plan or an individual retirement account is up to you, but make sure you’re never leaving any money on the table, such as from an untapped employer match to your 401(k).
Retirement aside, the right investments for you will depend on your risk tolerance. Stocks are generally riskier than bonds. To lighten the risk, you can turn to mutual funds.
They can help provide diversification among stocks, bonds and other investments to reduce the risk from each one individually. Your risk tolerance can be factored by income, age, lifestyle and when you’ll need the money.
Carrying debt can be stressful, and if it negatively impacts your mental health, you may want to prioritise paying debt down first. Debt can completely derail your financial goals. It eats through your savings and can offset the gains you make through investing.
On the other hand, you may have a better chance of a bigger reward with smart investments, so you may decide that’s worth the risk.
Keep in mind that investing doesn’t come with guaranteed growth. Any average or likely rates of return you may see are often based on long-term performance; you may experience higher highs, and lower lows in the short term.
If you choose to invest, by no means should you stop paying off your debt entirely. You should aim to at least make your minimum monthly payments before you put any spare cash toward investments.
You really don’t want to miss your minimum payments. Think of your minimum debt payments as fixed expenses. After regular living expenses, minimum debt payments should be the next priority. Failing to do so, could lower your credit card score making it harder to qualify for future loans.
The younger you are when you start investing, the more time you have for your investments to grow. However, there’s no guarantee that you’ll make money when you invest, as the market can be volatile.
If you’re relying on an increased balance within a short amount of time, you might be disappointed. Whichever decision you make, your decision is never set in stone. You can always switch up your budget if your financial situation changes or if you’re unsatisfied with how you’re currently allocating your money.
The important thing is that you’re taking charge of your financial future. Make sure you have an emergency fund in place before you use extra money to contribute to these goals. An emergency fund should contain between three to six months’ worth of expenses that can protect you in case unexpected costs come up.
Without a financial safety net, you’re one unexpected medical bill, car accident or surprise expense away from even more debt. Some people, particularly those worried about income loss, prefer building a large cushion of cash for emergencies first over paying down extra debt.
By using automatic deposits, you can create an investment plan and stick to it over time, treating your investments as part of your fixed budget. Your safety net will give you some financial breathing room, and before you know it, you’ll be making progress toward retirement, a down payment on a house, college for your kids or whatever goal you had in mind.
As you approach saving, investing and paying off debt, keep in mind that it doesn’t have to be all or nothing. You don’t just have to focus on one thing at a time. If you do, it could end up taking longer to start working on each of your goals, which could delay your success.
The best path to long term financial sustainability is paying off debt and investing at the same time. This approach will help you improve your financial discipline, and will ensure that all of your hard-earned cash takes you one step closer to achieving your financial goals one cent at a time.
Try and find a balance between everything. While it can take a little longer to achieve each goal this way, it can give you a more well-rounded financial foundation and pay off in the long run.
When making decisions about debt reduction and investing, keep in mind that the need to eventually pay off principal is certain, but investment returns are not. Investment performance will vary over time, and it’s possible to experience losses as well as gains.
At the same time, it’s well known that investors who start earlier can benefit from compounding and time in the market.
But there aren’t any magic numbers. That’s why it’s important to work with your financial advisor to create an investment strategy that fits your financial expectation for the future.
Having some extra cash is an enviable situation to be in. When making decisions about debt and investing, be a long-term thinker: Think about the position you want to be in the next ten or so years. Then evaluate what actions today will be most effective in helping you achieve your long-term financial goals.
Whether to invest or pay down your debts is a decision only you can make. Whichever you choose is better than merely spending it. You’ll be in a better financial situation than you were in before.
If you’re interested in getting my savings and budgeting guide or retirement guide, click on the link in the descriptions.
Well, thank you all so much for reading. Until next time, take care!