Are you trying to decide between paying down debt and investing ? While reducing your debt may seem like the obvious choice, it may not be right for you.
In a recent Instagram post , financial educator Tiffany Aliche said to evaluate your priorities before choosing where to put your excess cash. Ask yourself these three questions to help you decide whether to pay down debt or invest .
The type of debt you have and the interest rate on it play a critical role in the decision. Is your debt on a credit card with a double-digit interest rate, or is it an auto loan with a relatively low rate? Aliche said to prioritize high-interest debt like credit cards before investing extra cash. A general rule is to pay off any loan with an interest rate of 6% or higher before investing.
Low-interest debt, like mortgages, federal student loans and car loans, might be worth delaying repayment if the interest rate is below 6%. Diversified investing can earn between 7% and 10% annually, potentially exceeding the cost of cheaper loans. It’s worth noting that maintaining low-interest debt can also improve your credit score as long as the account is in good standing. In general, your credit score improves as your credit history gets older.
While paying off debt is pretty straightforward, investing requires additional research and discipline. Aliche pointed out that if you don’t have time to educate yourself about the stock market, prioritizing debt repayment may be a better choice. She said that clearing debt can also be a form of investing because it immediately increases your disposable income.
If investing seems too intimidating or tedious, index investing may be a good place to start. For example, purchasing an exchange-traded fund that tracks the broad market, like the S&P 500, could offer a simple way to diversify your portfolio without much research.
Do You Prioritize Stability or Future Wealth?
Aliche emphasized that you should evaluate your financial goals before making a decision. Are you more inclined toward a conservative approach, favoring immediate financial security? Or are you willing to take on additional risk in pursuit of greater returns? If you lean toward the former, Aliche said that paying down debt can reduce stress and bring peace of mind.
If you’re comfortable with more risk and dream of turning your current cash into more, investing may be the way to go. Let’s say you invested $1,000 right now. With a 10% annual return, that $1,000 would be worth about $2,600 in 10 years. If you added $50 each month to the original investment, compounded returns would increase the total to almost $13,000 in the same time frame.
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