It’s important to invest in your future. However, when you have debt, the choice between investing and paying off debt can be complicated.
You will lose out on compound interest if you pay off your debt before investing. However, if you invest before paying your debt, you’ll be stuck with managing it and paying potentially high interest rates. You also could damage your credit score.
Here are a few factors to consider when deciding which is best for you, paying off debt or investing.
Manage your debt
It is important to set up your debt payments according to which are costing you the most. Loans with the highest interest rates should be paid back first. If you have numerous credit cards or consumer loans, it may make sense to increase your payments to get some of these paid off.
Don’t pass up a matched 401k
You should set aside the maximum amount your employer will match for your 401k, even if this means it will take longer to pay down your debt. Employer matching is free money, and it almost never makes sense to pass that up.
Compare debt interest to other categories
Take a look at the amount of interest you pay each month on your debt and compare it to other typical categories like entertainment, rent, or food. This simple comparison will show you what you could buy if you shed yourself of your debt, and can be a very motivating tool to get your finances in order.
Pay special attention to student debt
For younger people, financial advisers will generally recommend investing before paying off low-interest student loans. For parents or grandparents, in or nearing retirement, who have taken out loans for children and grandchildren, the opposite is true. You don’t want a loan and interest payment nagging you when on a fixed income.
Consider your tolerance for risk
Investing is inherently risky and deciding if it is better to invest or pay off debt depends on multiple factors, including your income, age, earning power, timeline, and tax situation.
If you have a high proportion of disposable income, your risk tolerance may make investing the right choice for you. The longer your timeline, the more risk you’ll most likely be able to take on. If you’re concerned about your shorter-term finances or are anxious about possibly losing money through investing, you may be more at ease using any excess cash to pay down debt.
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