Debt is a ticking time bomb!
When it comes to debt payoff versus investing, it’s important to consider the pros and cons before making your choice. The answer to the question is unique to each individual and family. Less unique to each situation are the benefits of having an emergency fund; before you start crushing debt or investing, remember the benefits of building a comfortable cash cushion. Consider the following:
- What are your goals?
- What might your future look like?
- Emotions: What decision would make you [and your family] happiest? Better off now versus in the future?
- How would you feel if you paid off the debt? Would you sleep better?
- What does your risk tolerance look like? How would you feel if your investments lost money?
- Time: Investments that have a long time horizon tend to grow with less risk
- Risk vs. Reward:
- Debt has a somewhat risk-free return which may be known
- Investments may have higher upside and downside
- Mathematically: Paying off debt may be more risk free while investing tends to involve much more risk.
- What does reasonable upside look like? Downside? And can you live with it…?
- Example: it may make more sense to pay off a credit card with 17% interest as oppose to making an investment with an assumed 6% return
What about when the percentages are much closer? Or better yet, what if the percentages are unknown?! I prefer to decrease my risk by hedging my bets and “putting my eggs into multiple baskets.” You can diversify by creating a budget/plan to pay off debt AND invest for your future. By doing both, you’ll reduce the risk of missed opportunity should one of the decisions work out better than the other. Of course, you can split it 50/50, 60/40, 75/25, etc.. to meet your personal preferences.
In general, I am a big fan of reducing debts that carry an interest rate above 5%. For me, 5% is a reasonable and fair amount of guaranteed interest. However, it’s crucial that you have a big-picture view, long-term plan, and fully understand your personality, emotions, time, and risk versus reward.
- Big-picture: Understand your work benefits! If you receive a company match on retirement investments, then it may make more sense to contribute to receive the match. Then, use the remaining funds to reduce debt.
- Long-term Plan: How long debt repayment will take, what’s on hold, what’s next
- It does you no good to focus on paying off debt FIRST, while putting investments on HOLD, if you’re not tracking your spending and thus you continue to go further into debt.
Sexy Tip: Assess your “debt payoff versus investing” situation every 3-6 months…something will inevitably change. Now, go kick some ass.