When extra money goes into the account, people have to decide whether to pay off debt or invest. Is investing rather than paying off debt faster a good option?
If the return on your investments is much higher than the interest you will pay on debt, it is a good idea to invest. Repaying debt means reducing stress, reducing risk and increasing the ability to withstand personal emergencies.Living debt free will also make it easier to endure an economic downturn or depression, and you will have greater flexibility that can maximize personal happiness. Investing means building a reserve that can protect the future. See how to decide.
Paying Debts or Investing: That’s the Question
In short, if you have a realistic probability of earning more from your investments than you would pay in interest, it is usually better to invest with any extra money you may have.
An obvious example: If you have the choice between paying 19.9% interest credit card debt or investing in a mutual fund that has historically produced 10% annualized returns, it is a better idea to use the excess money you have. have to your credit. When you get some extra cash, it can be difficult to determine whether to invest or use it to pay off a debt. Financial theory recommends that if the after-tax return on investment is greater than the cost of after-tax debt, then you should invest. However, remember to consider the inherent risk of the investment you select, meaning you may lose the money you invest and still have to pay.
The worst debt is credit card debt because the interest rate is so high, just over 15% on average.
This debt needs to be dealt with as soon as possible and you need a plan to do so. Choose a method to repay this debt as soon as possible and focus on getting rid of it.
Have a financial reserve, even if it is low
The financial reserve is between debt and investment because that is where it falls under the hierarchy of personal finance priorities. High interest debt should be your priority. Even if you are not making much money, you can still invest and increase your wealth. Part of your investment strategy has to generate passive income for you.
Pay off debts when…
Debts have high interest rates
At this point, the question of investing or repaying debt basically boils down to two variables:
- The expected return on investment
- The probability of getting this return
It is reasonable to expect a balanced portfolio to produce long-term returns in the range of 6% to 7%, but this is not guaranteed. It could be bigger or smaller and anyway the journey will be full of ups and downs.
On the other hand, the return you get from debt repayment is absolutely certain. This certainty makes it easy to pay off high interest debts before contributing extra money to your investment accounts.
Already paying the minimum debt
Given that your payment history is the biggest factor in determining your credit score and that your credit score affects so many areas of your financial life, not just paying the minimum is essential.
Paying debts on time is the priority. This will help you build a positive credit history and most importantly, it will prevent you from unnecessarily damaging your credit and making the rest of your life more difficult.
Create a sustainable plan
While the temptation is to dive in and start putting your money to work, it’s usually a good idea to step back and make sure you have good control over your budget.
The goal is not to manage your finances or to judge your spending habits. It is simply creating a system that allows you to make consistent progress without going back into debt. However, doing so by identifying how much money is coming, where you are going, and how much you have relatively available to invest in your investments or debt will help you create a sustainable plan that you can really stick to.
Find your balance
Although the first decisions here are pretty straightforward, the question of investing vs. Paying off debt quickly becomes obscure. Without a definite answer, you may feel anxious to make the wrong choice and avoid doing anything. If that’s how you feel, it’s worth remembering that both are great choices and any progress is good progress.