Investing vs paying off debt, which is best? Unfortunately, it’s not an easy decision. Depending on where you go you’ll get different information because everyone has a different opinion. This isn’t going to be any different, unfortunately, haha. I’m going to be completely open with you guys and talk about the pros and cons of each side and truly let you make an informed decision for what is best for your life.
Regardless of which way you decide to go in the investing vs paying off debt debate, you should always have an emergency fund first. This emergency buffer is a great way to keep you sane and that will help you make much better decisions!
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What’s the most important factor?
When thinking about this debate, the most important thing to keep in mind is your interest rate. Why? Because to really make this decision you need to compare the amount of money you’ll get from an investment to the amount of money you’re going to be paying towards interest on your debt. Sounds easy right? Well, kind-of.
When you start investing you’re going to get an interest rate around 10%. Sometimes a little higher, sometimes a little lower but finding an interest rate way higher than that is going to be hard unless you take some big risks.
You should always pay off any of your debt that is higher than a 10% interest rate! Always. Before you invest! This means that pretty much any credit card debt you have should be paid before you start investing. You can usually get away with your car loan and/or mortgage loan because the rates are going to be lower.
You never want to be putting your money into an investment where you get a 10% return when you’re paying 19.99% on a high-interest credit card. You’re essentially just throwing your money away.
How do you feel about risk?
No matter what you’re doing with your money, you need to consider the risk associated with what you’re doing. If you’re young, you’ll have so much more time to make the money to pay off your debts and make a decent return on your investment.
If you already know you’re super risk averse and will freak out every time the market takes a small dip, you’re definitely better off paying off your debt so the return is guaranteed. You’ll feel a lot better about the risk when you don’t have the chance of losing your home because it’s totally paid for!
The Compound Interest Factor
Now, let’s go into a discussion of compound interest! Compound interest is the main reason people start investing before they are debt free. It’s a great way to get your money to work for you! So what is compound interest?
Compound interest is the interest paid not only on the amount you invested, but also the interest you get on all interest you’ve already been paid! This means you’ll get more money in interest every year that it’s invested! This is a key reason why you may want to start investing before you pay off your mortgage and/or car loans.
This is the time when being young pays off. If you start investing at 25 years old the amount of money you’re going to be making because of compound interest is going to be crazy if you have 25 years to invest, as opposed to 10 years if you’re 40!
The debt-to-income ratio factor
When making any decision you should really look at the math and see what you can actually afford to do! Your debt-to-income ratio is a very important ratio to consider when making these decisions.
So, what is a debt to income ratio?
Your debt-to-income ratio calculates your monthly payments that you make toward debt and compares it to your total monthly income after taxes.
For an example, if you make $5000 in a month, and you have a mortgage payment of $1250, a car payment of $300, a $400 student loan payment, and $300 of other random debts, your total debt payments for the month is $2,250. This means your debt-to-income ratio is at 45% which is not recommended!
You want your DTI ratio to be somewhere under 35% for financial security!
If you’re in that kind of situation with a high debt-to-income ratio, you’ll want to pay off some of your debts before you start investing just to make sure you’re more secure.
Investment Returns are never guaranteed
The market is never going to provide you with a guaranteed return. You never know what is going to happen. However, chances are your home is going to be a guaranteed return if it’s in a good area and nothing catastrophic happens. If all goes well, you’ll get your investment back and usually a few thousand dollars in equity as well!
You need to remember that no matter what you’re going to have to pay down these debts. They aren’t going to just up and walk away (wouldn’t that be nice?)!
Which is best for you?
There’s a really helpful calculator on Practical Money Skills Canada that can really help you to make this decision based entirely on math. This decision is entirely yours. You should never really take financial advice from a stranger on the internet (hehe, me). I’m just here to provide Y’all with the facts and let you make an awesome, informed decision that is right for you.
I’m always here to be open and honest with all of you. Personally, I started investing for the first time in January of 2018 and it scares me because I still have student loan debt and I really want to get rid of my debts before I invest any more money. Thankfully, I’ll be out of student loan debt by January 2019 which just makes me smile to think about! Then I’ll be an investing powerhouse.
Let me know in the comments if you’re in debt but still invest, or if you’re in debt and are too scared to invest. Just leave me a comment because I love you all and I’m so grateful that anyone reads this stuff! Thank you so much for reading,