Should I Invest My Savings or Pay off Debts?
Happy December everyone! As I sit here in my cozy home office overlooking the thin layer of ice on the pond, fireplace roaring, warm fuzzy socks on my feet, I can’t help but count the days until I’m in shorts and walking barefoot on the beach. Yep, you all know me, I’m looking forward to the warmth of the sun and escaping the howling cold wind of the winter. Yet others are gearing up for this winter as their favorite time of the year to ski, ride snowmobiles, hunt or hike the snow-covered paths.
Everyone has their desired lifestyle differences and much of it depends on your personal tolerance level, risk tolerance, knowledge level and age. All of these factors should also be considered in part when answering a question that was asked at the recent Women’s Financial Conference: “Should I pay off debt or pay the minimum and invest at the same time?” I’m sure you are thinking, it would be nice if she just gave a yes or no answer for a change, but no such luck! (For related reading, see: How to Piece Together Your First Portfolio.)
Understand Your Debt First
- What is the interest rate on the debt? If you are paying 0.9%, but could defer money into an IRA or 401(k), I would likely recommend that you keep the debt, for the tax benefit alone would likely work out better for you.
- What type of debt is it? Is it a student loan, mortgage or home equity loan, credit card debt, auto payment? If you are paying 12% on a student loan, I would probably tell you to focus on getting that debt down as quickly as possible, then taking that payment amount and investing it once you are done.
- Will saving the money help you achieve your goal? If you want to put 20% down on a new home in the next couple of years, then you may want to be putting as much money aside as you can. One caveat here – I’m not saying increase debt during that time, I’m just saying if you have quality debt, you may want to hold off on paying it down until you have set aside money for emergencies and for a big goal – then hammer the debt. Or, if hammering the debt will then allow you to save for that big goal – pay it down.
- If debt is keeping you awake at night, eliminate it and then stockpile the amounts that you were using to pay down the debt to save aggressively.
- I also take into consideration if you are able to save with an employer 401(k) that has a match, I don’t want you to give up free money (unless it is for a very short term).
- I also think it is extremely important to create an emergency fund – nothing worse than getting your debt paid down and the refrigerator needs replacing and the balance on the credit card goes back up.
- Your age also comes into this mix because if you are getting ready to retire, we generally want you debt free – so focusing on reducing debt might be the most important thing; whereas, if you are just out of college, we might want you to be building the emergency fund first.
Once the emergency fund is created, I recommend creating a debt elimination plan. Sit down and list out all your debt, the payments you are making, the interest rate you are paying, then pay down that smallest debt first, making just minimum payments on the others. Once that debt is done, take the payment from that and “roll it up” to the next biggest debt. By the time you have two or three debts paid for, you are making large payments on the biggest loans. Studies have shown that when you feel like you are progressing, the momentum will keep you focused on your goal, so knocking one off at a time (the smallest first) feels rewarding. (For related reading, see: 4 Easy Steps to Create Your Own Budget.)