To pay off debt or invest? The age old question. What is best for your situation? Of course that is what it all depends on. Your personal situation. There is no one size fits all answer to this question. But! We will do the best we can to give you the right thought process in evaluating your situation and coming up with your best course of action!
To Pay Off Debt or Invest: The Debt Argument
I LOVE the idea of not having debt. It doesn’t matter how big or small the debt is. I don’t want it anywhere near me. Paying off debt is beyond satisfying. It is hard to describe in words the feeling of knowing you no longer have that payment hovering like an anvil over your head.
Debt comes in all shapes and sizes. You can have debt that has payment terms for less than a year or a mortgage for 30 years. Interest rates range from the low single digits to over 30%. All of these factors should go into your decision on whether to pay your debt off first or invest your extra cash.
Paying off debt means you are getting a guaranteed rate of return on your money. While your money doesn’t grow in the traditional sense, you are still using the power of compounding to your advantage! Any extra dollar you use to pay off debt is a dollar less that is being used to calculate the interest that you owe. As the old adage goes, “A penny saved is a penny earned”!
If, at the beginning of your mortgage of $200,000 with an interest rate of 4%, you pay an additional payment of $10,000 with your first monthly payment, you will save $21,307.70 throughout the life of the loan. And you will have the loan paid off over 2 and a half years earlier! Again, that savings is guaranteed. Once you pay that additional balance, that savings is set. As long as you continue to make your monthly payment of course!
To Pay Off Debt or Invest: The Investment Argument
Depending on the variables of the debt you have, would it make sense to invest your extra money instead of using it to further your debt payoff?
Investing can be a crap shoot. Sure, you may have rates of return higher than 10%. Those feel great! But you may also lose money which can lead to a feeling of dread.
The market has performed at an amazing rate of close to 10% since the beginning of time. This has come with its fair share of ups and downs but the numbers don’t lie. There is money to be made by investing in the market. The problem is knowing what to invest in. I will discuss this more in-depth in a later article but, for the average investor, low cost index funds are the way to go. Buy one that tracks the market and let it be. You won’t be disappointed.
Getting your money into the market as early as you can is key to investment growth. The longer your money has time to grow, the more you will have. Seems pretty simple right? See the chart below:
At a conservative rate of return of 7%, $10,000 will grow to over $76,000 in 30 years! That is with no additional investment during those 30 years. But look at those investment gains in the last 10 years! After year 20, your money has grown to a respectable $38,000. Leave it in for 10 more years and you have doubled that into $76,000! Patience is a virtue!
What’s the Verdict?
You may think the numbers show that the answer is simple. Investing wins by a landslide! Well….not so fast. As discussed above, those gains on investments are not guaranteed. Sure, history shows that over time, the market will increase. But can you be sure? Remember, past results to do not guarantee future returns.
This is a personal decision. If you like the security of a set earnings rate, pay off your debt. If you are willing to take a higher risk, go for investing, but if you have debt that is higher than 6%, then my recommendation would be to pay that debt off. Any gains you will steadily get will not be much higher than the 6% so take the security. I will fight that argument to the grave!
What Does Dead Debt Do?
For months, I struggled with this very question of debt payoff or invest. I would go back and forth between the two. My student loans were priority number one, but once they were gone I had a decision to make. Was it time to start hitting the mortgage as hard as we could or should we start putting extra into the market?
After a few months of thought, I came to a realization. With both my wife and I maxing out our 401ks at work and maxing out my Roth IRA, we were already putting $45,000 into the market. Sure, I could put more into the market but why not diversify by paying down the mortgage faster! In my situation, the two events were not mutually exclusive. No matter what, money is being put into the market every other week. I could put extra money to the mortgage without having to worry about not investing!
You Have the Power
As with many financial decisions, you have the power to decide the best route for you. My job is to give you the tools to make the most informed decision possible.
Use the debt payoff schedule I provided you in the article about amortization schedules and included in the Downloadable Templates tab of the website. Run different scenarios on your debt. See the different outcomes. Just this simple exercise will open your eyes to how you can make a difference with even a small extra payment.
No matter what your choice, know what truly matters is you are making steps in the right direction. You could spend the money on anything, but you are choosing to pay yourself first. That is honorable. Most people don’t do that but you are different. You are destined to be successful!