This is one of the most common questions I get asked when it comes to money. Which is more important: Paying down debt or Investing?
It’s not an easy one to answer because everyone’s situation is different and there are strong opinions on each side of the argument.
In most cases there is a somewhat “right” answer though.
If you have read anything on this blog you have likely heard me say that winning with money is more about behavior than it is about math. That holds true here as well but in this case the math can make a huge difference.
We’re talking potentially hundreds of thousands or more dollars in difference.
Before we get to that though a big factor is making sure that you have an adequate emergency fund. If you don’t have one or don’t know what an emergency fund even is check out this post.
If you do have one make sure it’s enough to cover a significant emergency or temporary job loss.
The reason I bring up emergency funds is this: Before we can even start thinking about choosing if you should pay down debt or invest we have to make sure you aren’t on the edge of a financial cliff.
So step one is to stop living on the edge. Get some money saved up for emergencies even if it is just a few thousand dollars.
Let’s say you are already at that point, now we are ready to debate which is better: Saving vs. Investing.
Investing is powerful and nothing is more powerful when it comes to investing than starting early. Time is critical!
If you are 30 years old and you saved $300 per month, (That’s half an average car payment) invested it in the stock market, and left it until you turned 70 you would have: $1,752,000.
In case that didn’t make enough of an impact, that is: ONE MILLION SEVEN HUNDRED FIFTY TWO THOUSAND DOLLARS.
I’m assuming typical market returns over time (10%).
But let’s say instead you waited 10 years to get all your debt paid off. Then once you turn 40 you start putting in the same $300 per month until you turn 70. Now at 70 years old you have $651,000.
Not bad, but you missed out on over one million dollars because you waited 10 years. Crazy right!
Here is a chart to help display the massive difference ten years makes:
This is why most of what you will find out there from “money experts” is advice telling you to not worry about debt so much but invest early and a lot.
From a math perspective they are not wrong. We just saw why.
But they aren’t necessarily right either. Confusing right?
The reason has less to do with math and more to do with you. Quality of life, security, and reduced financial stress in the present are worth a lot even though we can’t put a dollar figure on them.
You have probably heard that the leading reason for divorce is money related issues. I’m not sure if that’s true still but if not its top 3 for sure. Money is personal. It causes crazy amounts of stress and anxiety.
And what makes money more stressful than anything else? DEBT and debt payments.
Debt can be scary. If you have ever been laid off and if you have fallen behind on payments you know what I mean. Creditors start calling nonstop. You feel guilt and shame because you can’t pay what you know is owed. Just the thought of that possibility causes anxiety for most of us.
What if that weight could be lifted off your shoulders? What if you had no payments, no interest, and no creditors? That feeling would be priceless.
That is why Lauren and I committed to living without loans when we got married. The reduced stress around money positively affects our relationship and our quality of life.
And don’t forget that when you pay down debt you get a guaranteed return on your money too, because you save on interest that you would have had to pay. In many cases you can save tens of thousands of dollars by paying down your debt early.
Back to the question. Should you invest or pay down debt?
The math says to save early, but the more emotional and quality of life side says to pay down debt.
It is situation dependent so I will answer it in a few ways. Most people will fall into one of these categories or close to it.
The first one is: Drowning in debt/Way more debt than you should have
If this is you, you have car loans, student loans, multiple credit card payments, possibly a mortgage, and maybe even more debts out there. Some of that debt has very high interest rates.
Worrying about your debt might be keeping you up at night. You may be current on all of your payments, but you are living paycheck to paycheck to barely make it.
The answer for you is that once you have a small emergency fund in place you need to get a plan and get out of debt as soon as possible.
All of your available resources should be going into making this happen and all investing should be put on hold. If you need help building a plan to get out of debt a great place to start is this article about using the debt snowball.
The second scenario is: You have some debt but it’s not out of control
This will probably capture a big portion those reading this. You have a student loan and maybe a single car payment, maybe even a mortgage. You don’t have any high interest debt like credit cards. You are able to make the payments and though it would be nice to have them gone your debts aren’t crushing you.
You probably worry about finances but it’s not worrying about how you will make it to the next paycheck. You are more focused on how you will ever get ahead while you constantly have student loan and car payments to tackle.
If this is you the answer is a little more complicated. If your work has a sponsored retirement plan like a 401k and it has a match, you should be taking full advantage of that match.
In my case if I contribute 5% of my salary my company will match 4% of my salary on top of my contribution. It’s like getting a 4% raise and it will grow over time. Take advantage!
This is still similar even if you don’t have a company match. You should star by investing around 5% of your income into a tax favored retirement account like a Roth IRA.
But anything beyond that 5% or the amount needed to get your full company match should be going toward getting out of debt up until the point when all you have left is a mortgage.
The reason for this is: Debts are weighing down your ability to maximize the potential you have to live, give, and invest.
They also create an emotional weight. Even if you aren’t overly worried about debt things like car payments and student loans create unneeded stress on you and on your relationships. They also create risk if something unexpected were to happen.
Could you invest a little more and still go after your debts? Sure and it wouldn’t be a terrible financial decision. But living without debt as I shared before has financial benefits that cannot be quantified. Getting out of debt as soon as possible is critical to reaching your financial goals numerically and emotionally.
Alright last one: You don’t have any significant debt other than a mortgage.
I’m going to assume your mortgage rate isn’t something crazy high and if it is you probably need to refinance if at all possible. Most mortgages out there are between 3-5% for a frame of reference.
If that is you, you should maximize your investing. Most experts agree that you should be saving/investing at least 10% for retirement. Some even recommend 15%. You could invest more on top of that for other things as well, but at least start with retirement.
You hopefully have a work plan matching that as well. By saving like this as early as possible you will likely have the opportunity to retire a millionaire.
You could possibly retire early, buy that lake house you have always dreamed about, or that sailboat, or car, give to charity, give to your family or friends, etc. You can leave a legacy for your children and grandchildren. The possibilities are awesome to think about.
By investing early, as much as you can, you open up all sorts of possibilities for your future. You will not be “financially trapped” or a slave to payments and working long hours.
That is the dream!
Whichever of the three categories you fall into the key is to go after it as soon as you can. Start today.
Get some money set aside for an emergency. Even if you have zero dollars set aside right now getting a few thousand should take most people 6 months or less if you are truly committed.
Next if you have too much debt, go after it with everything you have got! If you are in the middle and you have some debt, invest a little and use everything else to go after that debt! If you only have a mortgage, invest like crazy! You can tackle the mortgage early too, but don’t neglect your ability to grow your money by investing.
Everyone has the potential to be successful regardless of salary and situation. If you will commit yourself to a plan and take it one day at a time you will get there and it will happen much faster than you imagine.
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