Most people often wonder whether to pay off their debt or invest. However, the answer to this question is really complicated. As it is, paying off your debt or investing both are necessary and admirable. There are different reasons to it.
Paying off your debt means:
- Lower risks
- Reduced stress and
- Greater ability to bear with personal emergencies.
Living a debt-free life will also make it easier for you to endure depression or an economic recession. You will have an increased flexibility that will enable you to maximize your personal happiness.
Investing, on the other hand means:
- Building an adequate reserve
- Providing protection to you and your family and
- Providing you with other sources of passive income.
Investing perhaps and most importantly means accumulation of enough money so that you can retire comfortably.
Table of Contents
How To Invest When You’re In Debt
Given the benefits of both investing and paying off your debt, you may wonder now what you should do. Theoretically speaking, there are ideally two most significant variables to compare when you want to take an intelligent decision and choose the right course of action. The two variables that will influence your choice between investing and paying off your debt are:
- The rate of after-tax interest that you will have to pay on your debt and
- The after-tax rate of return that you can expect to earn from your investment
To put it in other words, you must invest when you see that you can earn higher return from it as compared to the interest on your debts. On the other hand, if the rate of return is low you must focus on paying off the balance on your debts.
You can put the money to work somewhere else in your investment portfolio and make lots of money in the long run but all this is not hypothetical and needs a lot of precautions and calculative decisions. Moreover, if you consider the risk adjustment factor, this may not be optimal always. It is therefore necessary to follow the set guidelines of the financial planners so that you protect your money as well as your investment and interest to get the best of both worlds.
Essential Read: 100 Awesome Websites To Earn Extra Money By Working At Home
Making the right choice
It is not easy to make a decisive choice between which debts to pay off and which investments you should fund. Ideally, there is a hierarchy to follow:
- Start with funding any retirement account you have at work such as 401(k) plan. Make sure that you fund up to an amount that you receive as any free matching money. Ideally, most of the companies provide matching amounts that range between 50% and 150% of the first variable percentage.
- Always build an emergency fund in something that is highly liquid, money market, FDIC insured checking, comparable account or saving.
- Depending on your eligibility, you may also fund fully a Roth IRA but make sure that you check the limits of contribution that may be imposed in any given tax year.
- If you have any debt carrying high interest such as credit card debt or student loan debt, pay it off. Prioritize your debts according to your choice and affordability. Ideally, a student loan being most difficult to discharge in bankruptcy must be paid off first. To know more about it you are welcome to visit nationaldebtreliefprograms.com . Stick to your debt payment and do not add to it at nearly any costs.
- When you contribute to your 401(k) account make sure it is up to the maximum amount that is permitted by the tax regulations and your plan.
- If you consider your retirement saving seriously make sure you consider a strategy that comprises Health Savings Accounts. This will act as another type of de-facto IRA in addition to your Roth IRA.
Apart from these you must also focus on building assets such as fully taxable brokerage accounts, directly held mutual funds, dividend reinvestment plans, and other cash-generating assets and even in a college 529 savings plan for your child or grandchild.
Reduce Your Debt Systematically
If you invest properly, you will achieve several things that will ease your financial condition, minimize the tax bill and provide more money in your pocket.
- You will be able to create enough bankruptcy protection for the retirement assets such as your employer sponsored 401(k) retirement plan. This has unlimited bankruptcy protection as per the current rules as it is for your Roth IRA.
- You will be able to reduce your debts significantly over time and ensure a free cash flow. When all your other basic needs are fulfilled you will make only riskier investments in different taxable accounts.
- If you have a small retirement account and a lot of debt you ideally should not invest in IPOs. Alternatively, you should completely debt-free and draw a line around your assets so that you do not have to worry about these being taken away from you due to non-payment.
Therefore, it makes more sense to pay off your debts first and then begin investing. This will work very well for you as it has for many people in the long run. This one step that can help to Invest When You’re In Debt free life.
The most significant thing that matters in the final analysis is you and your behavioral economics. You will need to factor into your decision between investing and paying off debt. These factors are whether:
- You can and want to live with it
- You are likely to stick with it till the time it is completed and
- You can sleep well at night.
You must have your end-game objective very clear as that will keep you going. Your objective should be to have no debt at all along with an abundance of lucrative and high paying investments. Proper asset allocation is the key here to maintain a proper balance between the risk involved and returns promised. This will ensure comfortable life for you and a high standard of living for your family. All it needs is a lot of patience, hard work and calculative decisions to achieve this goal of financial freedom.