Is it better to invest your money or use it to pay off debt? The answer to that question depends on many factors, like your investing options, the amount you owe, interest rates, and even your age. But as a rule of thumb, you should try to do both. Before you do, here are a few things to consider:
Compare interest rates
You can typically expect to earn more money by investing than you would lose by not paying off debt. For example, investing into a stock market index fund that returns 10 percent a year will put you further ahead than using the same amount of money toward paying off student loan debt with a five percent interest rate. If your debt is wrapped up in credit cards, however, it’s almost certainly more advantageous to pay that off first, as according to Investopedia’s credit card database, the average interest rate on credit cards is almost 20 percent. “Interest rates on credit cards are so high you can never get ahead,” says Linda Davis Taylor, former CEO of an investment company based in Pasadena, California. “Put yourself on a plan to eliminate your credit card debt, and be as disciplined as possible.”
Consider your credit score
If you have a low credit score, paying off debt can give it a significant bump. One of the most important factors that goes into determining your credit score is your credit utilization ratio, or the amount of credit you are using relative to the amount that is available to you. If your current debt is very close to the total amount of debt you’re able to have — that is, your credit cards are maxed out — then this can have a major negative impact on your credit score. Financial news expert Brian Beers of Investopedia says, “paying off debt, particularly if you have a lot of it, can be a smart move for that reason alone.”
Factor your age
Writing for TheBalance, personal finance expert Lora Shinn says, “In general, you should avoid carrying debt into retirement.” If you are nearing retirement age, you’ll typically benefit more from paying off debt than from investing. However, thanks to compound interest, it’s almost always better to invest in retirement as much as possible, especially if you are still a long way from retirement age. If your employer offers a 401(k) plan with matching contributions and you do not yet meet that match, this would be a good place to invest your money.
Try to invest and pay off debt at the same time
Investing — whether short- or long-term — and paying off debt are not mutually exclusive. “You can, and sometimes should, do both,” Beers advises. If you neglect investing, you risk falling short of retirement goals. If you neglect paying off debt, you will probably end up spending too much in interest over time. Additionally, you should try to put aside money for an emergency fund if you don’t already have one. “A good place to keep your emergency fund is a low-risk and highly liquid investment, such as a money market mutual fund,” Beers says.
Managing finances is no easy task, and it can be tricky to make the most out of your regular income or an influx of cash. Consult with a certified financial planner at your financial institution for expert advice that works for your own, unique circumstances.