Should your primary concern be to repay debts or to invest any extra money that you have to work with for accumulating wealth by adding to your savings?
This is a good and important question that we all need to address in our financial lives. It can be hard to determine which course of action will best benefit you at any particular point in time. Of course you have to manage each of the two options based on what you budget allows for. In any case, if you have just received a sum of money, such as a tax refund, or you are working month by month from you budget you will have choices that need to be made. It is important for you to consider the most effective way to allocate your money with your future in mind as well as considering your personal temperament towards debt the choices of paying down debt or saving more money.
Deciding whether to pay off debt or invest is a scenario that you’re likely to face at many different times throughout your life. The best decision for you will depend on your own unique financial situation.
It should not need to be said that the absolute best solution to this question is to not get into any debt at all if you can avoid it. Yes, that is the ideal, but for most of us our financial situation is far from the ideal. For most of us, debt has become an every day common occurrence. Making ends meet and trying to obtain some things in life, it does seem that the only way to go about it is to take on debt.
Car loans, school loans, credit card debts and the mortgage probably covers the debt list that most if us have in our lives. And yes, for the bigger things in life, sometimes taking on the debt is the only way to achieve them.
However you can manage your debts, it is possible to start roping them in. The problem is that we have limited financial resources and therefore we have our budget that we have to work with. Money allocated to one category of your budget means that that same money cannot be used in a different category.
- One of the most common financial questions that people have is, “What should I do? Pay Down my debts, or use my money for savings?”
If you’re facing the dilemma of paying off debt or investing your money, you might also be wondering if you can come out ahead with some combination of both.
Fortunately, there is a middle ground that allows you to pay off your debt while making smart investments to increase your current income.
Sometimes, investing instead of paying off debt may even be the more cost-effective decision. If your investment yields earnings greater than the interest on your debt, your money is better spent on those higher yield investments.
Let’s look at different scenarios to help you determine the most lucrative options for your own situation:
When Investing Is A Better Option – You Need To Look At The Numbers
You may only have a mortgage or student loan debt that carries with it a set monthly interest rate. Consider whether or not the interest from these loans is tax deductible may influence your decision to invest or pay off the debt.
When Choosing To Save More Or Allocate More Of Your Budget To Your Savings Plan, You Need To Consider The Rate Of Return For Your Money.
The Rate of Return or Rate Of Investment (ROI) is a way to measure the efficiency of an investment or opportunity and then to compare it to other opportunities.
So, when considering the ROR, or ROI, this path involves looking solely at the numbers. Regardless of which path you choose, you need to know what the numbers are and take them into consideration no matter which path you go by. When money is involved, the numbers are important.
Simply Put, What Is The Most Profitable Use Of Your Money?
Since not all debt is created equally, the solution isn’t always clear. Student loans, mortgages, and similar debt may have relatively lower interest rates than could be earned from investing and, therefore, you could potentially profit more by investing rather than using your money to pay these off early.
- Credit card debt, on the other hand, usually costs more. The interest rates on credit cards typically comes with an exorbitant interest rate, making it wise to pay this debt off as soon as you can. Dollar for dollar, the rate of return on paying off credit card debts or any other debts with high interest rates would often be better than investing that same money allocation.
- Make the time to check your credit card interest rates, or interest rates on other lines of credit that may be costing you money before you decide what to do with your money.
- Of course, saving for retirement is also essential, so you need to consider the options available here as well. Does your employer contribute matching funds to what you put into your 401(k)? Consider, as a minimum. investing at least the amount that your employer will match in order to double your money immediately.
Do Not Forget To Say “Yes!” To Free Money.
If you currently have debt and are employed by a company that offers a 401k plan, you are turning away free money by not enrolling. Saying “no” to a 401k is essentially leaving “free”money on the table.
- If the debt costs you less money per month than you could otherwise earn through profitable investments, then it is in your best interest to focus on investing.
When It Is Usually Better To Pay Off Your Debt?
As has been already stated, of the many different kinds of debt, credit card debt often carries with it some of the highest interest rates in the industry. These interest rates can now be as high as 18% to 23%, and trying to find investment options that yield such a percentage in earnings may prove difficult and if you do find them they usually come with a higher element of risk that is attached to them.
So, until you find an investment option that provides you with that percentage amount in returns, it may be in your best interest to focus exclusively on paying off the debt.
Investing And Paying Off Your Debt.
You may now be seeing the bigger picture regarding debt and investing. In essence, it is a balance of interest rates.
Finding a balance where you are paying off your high-interest debt while investing in financial vehicles that also provide a high percentage in returns is ideal. The investments will be more cost-effective than paying off your low-interest debt.
Along With The Numbers You Need To Consider Your Temperament.
You should look at more than just the numbers and take into account your own personal temperament as well.
- Are you the type of person that absolutely hates being in debt and cannot sleep unto your debts are paid off?
- Or, are you the type of person that sees that some debt is necessity to living and prefer to look ahead for long term goals while keeping the debts, at least, in check?
The question that you need to take into consideration is this: Where does your temperament guide you as to how your money would be best used? If you have a significant windfall, do you feel better investing it or using it to repay a large portion of your mortgage? The best answer for you will fall in line with your highest priority goals.
- It’s important to make the decision that you’ll be able to live and stick with, so consider all options when setting up the plan to concentrate on applying money to savings or paying down your debts.
- Generally speaking most debts erode your financial well-being. Being less in debt is an over-all good strategy if all other things are taken into consideration.
- By always working with having low debts to start with, if you needed to take on debt for some sort of emergency situation that your current emergency fund does not cover, it should be easier for you to be approved to get the loan at that time.
- Of course, having savings as collateral will always be beneficial to your financial situation whether you need a loan or not..
- You may want to speak with an investment professional or your family for advice. They may point out options you hadn’t considered.
Two Important Starting Point Considerations About Paying Off Debts Versus Savings Or Investing
Before you begin to pare down your debt or invest, there are two important things you should consider:
- The first is to ensure that you have an emergency fund so you won’t have to rely on credit in the future if a financial emergency occurs. Having money in your emergency fund will allow you to continue to live and to continue your savings or debt reduction plans.
- If your company has a 401(k), or if you have access to some other type of tax-deferred retirement savings plan, begin investing in it as soon as you can, even if you cannot invest a lot at first. At the very least, invest enough to receive matching funds from your employer.
You must seriously consider any saving plan, usually provided by an employer, where the company matches a percentage of your own investment or any other investment or savings plan that allows for income-tax deferral.
Keep in mind that very rarely do you have to rush to make a decision. Take your time and make choices that will benefit you both in the short term and for your future. Also know that you can switch your plans up when needed or once you have the debts or the savings under control.
Ultimately, It’s Up To You To Decide How You Want To Allocate Your Money.
Follow these tips to help you make a decision you will be able to manage and live with. Going further into debt to add to your savings will usually not result in a profitable outcome.
If you consider that your debt is like a leaking boat, the probable best step for you to do is always to plug the largest leak first. High interest credit card debt is by far the largest leak and should be considered your top debt reduction priority.
It’s also important to consider the fact that many loans can be paid in advance. Paying a loan in advance is more often than not the best return on your capital and should be done whenever possible.
If you’re still deciding on whether to pay off your debt or invest, make a list with your debt on one side, and investment options on the other side. Compare the interest rates from both sides and decide which of them demands your immediate attention first. Then your plan will be to choose the most lucrative solution at this time.
Lastly, A Few Things To Remember:
Be sure to review plan regularly. Hopefully your situation will change over time and therefore so will your priorities. What is working for you today, may not be the best solution for you in the future.
And do your absolute very best to avoid taking on any new debts. The more debts that you have, the deeper the financial hole that you dig for yourself. With the higher amount of debt that you have, getting out of the hole just becomes that much harder and harder.
Do Not Ever Forget The Old Saying That “A Penny Saved Is A Penny Earned”.
Any amount of money that is put to good use today has long-term beneficial affects for your future that can be worth more than the amount that was used today, in the present.
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BAM! Be A Man. Do The Right Thing. Take Care Of Yourself And Your Money
BAM! Be A Man. Do The Right Thing.
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