We all struggle finding the perfect balance in this financial equation: invest or pay down my debt? Many times the answer is “both—in varying degrees. And, it will depend on a number of different considerations unique to you and your goals.
You may hear that you shouldn’t be investing if you have debt because you’re wiping out the interest you earn saving. That’s not entirely the case, but everyone’s individual financial situation can change this debt or savings and investing paradigm.
Covering Your Bases
Remember that savings compared to investing have different objectives and risks. Your investments are never guaranteed and you could lose your entire investment up to—and including—your original amount. This is especially important if you’re saddled with a load of debt that you will have indefinitely. You can think about three key milestones to have in check as you answer this for your personal circumstance.
Pay All Your Bill Minimums
If you’re slipping behind in any of your debt payments or bills, hitting the minimum payment is a critical priority. Being behind on debt can affect your long-term credit and financial stability.
Have $2,000 in an Emergency Savings
Yes, that’s a super arbitrary number and your personal needs will look different. However, newer academic research supports that this is a good amount to start with. It can help cover a range of unexpected expenses.
Fund Your 401k Enough to Meet the Company Match
If your company offers a 401(k) match, do your best to invest enough to get the maximum company contribution. How do 401(k)s work? You invest with pre-tax dollars, and many firms offer to match some portion of your investment. It’s basically like getting free money from your employer, so taking advantage of it is a priority.
Nailed the Debt to Savings and Investment Basics—What’s Next?
Now we’re getting a little more nuanced around our individual situations. Again, you may want to meet with a certified financial planner or financial advisor. They can be sure that you are thinking about all of the individual factors that affect your own situation.
Here are three key things to think through as you approach this next level of consideration:
- The rates you’re paying on your debt and earning on your investments.
- The different types of debts you have and investment opportunities available to you.
- Your personal life stage and family needs or goals.
Yes, this is gong to take a little bit of work. (And, the needle moves often—most of our debt and savings rates are changing monthly, if not even more frequently!) Even though it’s a moving target, it’s a helpful exercise to understand exactly what rates you’re paying on your debt, and what you’re earning on savings and investments.
Mark up the highest rate you’re paying and the lowest rate you’re earning and do some additional detective work. First off, did you know you can often negotiate credit card rates? Especially if you’re a longstanding customer that pays on time, a quick phone call to check in on possible rate reductions is a worthwhile attempt. On the savings front, be sure your money is working as hard as possible and consider looking for a higher-yield savings, or a product targeted to your specific savings goal. Seeing those two rates on either end of the spectrum should give you a good perspective as to where your dollars can best be utilized. Start putting together a debt pay-down plan to tackle that high interest rate.
Debt and Investment Types
Not all types of debt are created equal. Interest rates are only one debt characteristic. Take student loans for example. Many of us are working to pay those off, and they can be a huge part of the loan profile we start our adult lives with. That said, many student loans have tax benefits, some have fixed interest rates, and even others are eligible for discharge if you have a certain type of career. Your employer may also offer different types of student loan reimbursement as an employee benefit. The combination of those features could mean that you don’t think about them in the same way you do other consumer debt you may have.
It’s features like these that are really important to understand when you’re considering what you should be paying off next. The same is true for investments! Accounts like Roth IRA’s can have some tax advantages or other features that may make it more personally advantageous.
What Do You Need?
It’s impossible to boil down our personal financial situations to mere math. Behavioral economics can influence how we respond in the debt-versus-invest debate in a major way. This means that social, cultural, and other psychological factors affect how we make financial choices. It’s never a great idea to make financial decisions completely from a gut feeling or emotional place. However, we can (and should) let our personal needs and comfort levels affect how we decide to allocate our money toward these major goals.
For example, we know that debt is one of the number one stressors in a relationship (with ourselves and others, actually)! Are certain debts chipping away at your well being? Then it might make sense to put any new savings or investing plans on hold until you can wipe out the liabilities side of your personal balance sheet. Ultimately, you’re the only one who knows that magic formula of debt pay down versus savings and investing that works for your personal financial, tax, and family situation.
What factors have you weighed when thinking about paying debt or investing?