The Case for Investing Over Paying Off Debt
The Investing vs Paying off Debt Ultimate Guide
Paying off debt can feel like a huge burden, especially if you have a lot of it and little income to speak of. When it comes time to budget, paying off your debt might feel like the only option — however, that doesn’t necessarily mean that it’s the best one. If you have some extra money to spare, investing might be the right choice for you — and the sooner you start, the more likely you are to see those investments pay off in the long run. Here’s why investing may be better than paying off debt when you’re feeling stretched thin financially.
Consider the long term.
The key to a good investment is that it can make money without you having to put in any more effort. It’s important to choose investments that are low-risk and likely to grow over time. If your debt-repayment plan relies on the appreciation or growth of your assets, you should probably look into investing those assets instead of paying off debt right away. For example, if you have $50,000 in student loans at 4% interest (which translates into $1,000 per month in payments), and invest that money at 6%, you’ll make an extra $100 per month — which would pay down your loan two years faster than just chipping away at it from every paycheck.
It’s hard to comprehend just how powerful compound interest is. The concept was so foreign when it was first discovered that Einstein dubbed it the most powerful force in the universe. It’s so big, in fact, that you only need to save $5 a day over 40 years and your savings will be worth more than $1 million! By contrast, paying off your credit card debt doesn’t carry nearly as much of an advantage. Think about it: Without compounding, saving $5 per day would result in nearly $40K after 30 years; however, if you invested those same dollars and earned 10% on average each year, your nest egg would have grown to around $500K after 30 years!
Take Advantage of Tax Benefits
If you are investing, many of your profits will be taxed at a lower rate than other types of income. If you pay off your debt, all of your money will be taxed as regular income. Of course, taxes aren’t really part of the math because it depends on how much money you make in both cases. The math tells us that if you’re young and making a lot of money — or if you’re old and have little or no taxable income — it may make sense to invest rather than pay off debt. But what about everyone else? What about people who want to save for retirement in their 30s or 40s? How does that fit into the equation?
You may be under pressure to get out of debt, but it’s important to note that paying off your mortgage (or car loan) is not always a better financial decision than investing. If you’re in a low-interest-rate environment, then your money is better off working for you than sitting there. However, if you’re one of the millions of Americans stuck with an underwater mortgage and can’t pay down your principal balance, then paying off your house faster and refinancing might make sense. The key here is to know what you can really do with your money in different scenarios. If you don’t know where your money should go, then it probably shouldn’t go anywhere at all!
Set aside some money for fun.
Although debt feels like a serious problem, it’s important to remember that life is about living and having fun. It’s best to set aside money each month for a rainy day or those “just because I deserve it” moments. Once you have an emergency fund established, pay off credit card debt with money from your paycheck. Once your credit card balance is zero, apply that amount of money toward student loans. From there, consider investing in index funds and low-fee mutual funds or saving as much as possible so you can reach your goal faster. If you’re concerned about not having enough income left over to support yourself while paying off debt, consider freelance work or picking up odd jobs on sites like TaskRabbit.
“Stash Away Emergency Cash”
You may be tempted to put your money in a high-yield savings account or certificate of deposit so you can get a better return, but it could cost you later. Cash is king when it comes to emergencies: A $1,000 emergency fund is vital protection against car repairs that cost $800, an unplanned trip to the hospital that costs $500, and job loss due to a downsized company. Make sure your rainy-day cash is somewhere easily accessible — and safe from identity theft. Your best bets are an interest-bearing checking account, a money market account, or an online savings account at an FDIC-insured bank like Ally Bank.
Don’t gamble. Place a bet on yourself.
Personal finance is often talked about in terms of gambling. You should invest, or you should pay off your debts. Instead of seeing investing as a gamble, why not see it as a bet on yourself? No one knows what will happen with your investments — but with any luck, they’ll make more money than you paid in fees and can be reinvested to create future wealth. If you make smart choices with your money, like buying dividend stocks or ETFs (exchange-traded funds), you could become financially secure without making risky wagers that might hurt your finances down the road. Use tools like an app like Personal Capital to keep track of your investments and spend less time gambling on risky strategies that won’t pay off if things go wrong.