Many Americans are strapped down with debt, with the average total household debt of United States citizens hovering around $132,000. Americans aren’t afraid to use credit cards to pay for groceries, gas, and other living expenses, averaging a little above $15,000. Those who graduated college here in the United States in the Class of 2016 found themselves in an average of $37,000 worth of student loan debt.
Most people hope to pay off their debts as soon as possible, as well as pad investment accounts liberally. Investments, when managed correctly, are a surefire way of earning returns on money that otherwise wouldn’t be used. However, the same dollar can’t be spent in two different places.
Should you invest or pay off your debts? Let’s look a little further into factors weighed into this tough, common question.
All Investments, All Debt, or Both?
Debt becomes larger over time thanks to compound interest, one of the wonders of today’s financial world. Similarly, investments grow in size largely the same, although with only simple interest, unless money earned as returns is reinvested into accounts they came from.
It makes sense to pay off whichever yields you the most money. If investments can earn, let’s say, 7 percent interest, while debts accumulate at 8 percent interest, it seems logical to pay off debt prior to investing. Conversely, if investments grow larger at 10 percent per year, compared to your debts’ 8 percent interest, it may seem more attractive to invest, rather than satisfy pesky debts. Unfortunately for hard-working United States citizens, debts require minimum monthly payments to prevent default and often-hefty late payment fees. Either way, if investments make more money than that debts lose, submit minimum payments every month and invest the rest of your disposable income.
However, it’s not always that simple.
Nobody in their right mind enjoys having debt, as emotional burdens often piggyback on debt’s broad shoulders. If you really hate debt, you might gain more utility from paying off all debt before investing.
There’s one more approach to dealing with investments and debts:
Investing hard-earned money and tackling debt with more than minimum monthly payments.
Tips to Dealing with Investments and Debt Simultaneously
Be Prepared to Deal With Problem Situations
It’s impossible to determine when financial emergencies will occur. Paying thousands of dollars to fix a must-have vehicle, home damages, pay legal fees, and other emergencies takes a toll on people emotionally and financially. One way to mitigate the damage caused by emergency scenarios is building up an emergency fund.
Traditionally, emergency funds pay, in whole, for three to six months’ expenses. This includes electricity, water, clothes, gas, food, and everything else you and your family needs to pay in one-quarter to one-half of a year’s time. A failure to pay debts, which may very well happen from emergency situations, results in sizable fees and hard hits on your credit score. An emergency fund will prevent these damages from happening.
If a situation like this arises, and you haven’t had a chance to build your emergency fund – research a reputable lender to provide emergency lending. Lenders like BMG Money provide financial resources in a pinch, at reasonable rates that will not hurt you long-term. Stay away from predatory lenders (i.e. “payday loan” companies).
Set Up Recurring Payments
Creditors absolutely love when their debtors set up automated payment schedules. This ensures they get their money, on time, and you prevent late fees. Win-win situation, as long as you have a positive checking account balance, at least.
Get Rid of Debt with Lofty Interest First
Various financial experts recommend different ways to pay off debt. Paying off balances with high interest charges is a sound idea, as balances — whether they’re small or large — snowball down proverbial hills at alarming rates when consumers pay minimum monthly payments.
Investment gurus that manage portfolios for a living strive to earn 7 percent from their clients’ money. It’s reasonable to assume that no matter where or how you invest your hard-earned, cold, hard cash, earning higher than 7 percent isn’t likely to happen. Therefore, you should pay off all debts with interest rates higher than 7 percent immediately. Make sure to pay off all other debts every month at minimum payments until high-interest debt is out of the way.
Match Your Earnings up to Employer Maximums
Most employers will match up to a certain percent, usually no more than 10 percent, the earnings that you contribute to a retirement account. Take advantage of this, if at all possible. Employers do have limits to contribution amounts. As such, it’s good idea to invest every dollar possible until you reach this limit, and then pause until the following year.
What Do I Do with the Other, Lower-Interest Debt?
Between 5 and 7 percent can be considered high-interest debt. If any of your debts are less than 5 percent, you can either invest it or pay off remaining debts. However, there’s always a chance that investments might not perform well. Conversely, when paying off debts, you can be certain the cash is going to good use.
Whatever you do, don’t invest in risky portfolios that promise ultra-high returns. Risk with these investments are scarily high. Money is better spent on interest-bearing debts until they’re paid off in full, rather than shooting for potentially-promising investments.