Pay Down Debt or Invest?
When it comes to paying down debt versus investing money, you may have heard the comment
“Why would I pay off my debt when I can earn more money on my investments?”
For example: A student loan may have an interest rate around 5% and the average return on the market is 7% over the long term. Therefore, some would argue it makes financial sense to pay the minimum on your student loan because your money earns more in the market. And I would agree… if it were that simple, but it’s not.
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First of all, market returns are not guaranteed. But you know what is guaranteed? The bank will earn their 5% on that loan if you make minimum payments. The truth is investments gain and lose money every year and there is no guarantee of growth. Additionally most of us are not Wall Street fund managers, meaning we still have a lot to learn about investing.
True story: When I was a few years out of college I bought stock of individual companies (which I do not recommend) that I felt had a lot of promise. Unfortunately my largest holding filed for bankruptcy. I lost all of that money, thousands of dollars, over night. If you thought, “ouch,” you’d be right. When I found out, I was almost sick to my stomach. What made it worse was that the money could have been used to pay down debt… so there I was, no money but the banks were still asking for theirs back. I felt pretty foolish.
In real life we usually pay bills, buy whatever we want, then save what we have left (which is usually very little). And we do that every month. On the contrary, when we focus on paying off debt we tend to make larger payments then we would ever put toward savings. Even with the best of intentions, if we don’t pay it to debt we tend to spend it, not save it. Therefore the “make more money in the market” argument is bogus because the money never makes it to the market!
It’s because of this that I firmly believe we should all pay down our debts as quickly as possible.
Here are three steps I used to prepare myself to take control of money and start investing:
- Pay off debt as quickly as possible. Lets just be honest, it’s super hard to save and invest when there is a mountain of bills on the kitchen table. So with serious intention reduce lifestyle and consumption spending. It won’t be easy but take the next one or more years of your life to completely eliminate your consumer debt and student loans. It took me about 3 years. It was well worth the effort. It helped me build deeper relationships and my true friends supported me… even if they did razz on me every now and then. And remember, this “reduced lifestyle” isn’t forever! If you make the sacrifice now, then you can really enjoy spending and giving your money later without feeling guilty about bills you should be paying because there aren’t any!
- Create and stick to monthly budgets. Before the beginning of the month decide how you will spend your money. Identify how much you’ll have remaining to pay off debt, save, and/or invest at the end of the month. Then you can almost make it a game to make sure that you don’t go over budget on any category so you have that money (or more!) to move into your investment account at the end of the month. If you have consumer debt, you can use this same method for paying down debt, instead of saving or investing money the money, use it to pay off some debts! Either way it increases your net worth!
- Treat saving and investing like a bill. Set up automatic recurring payments or transfers. Identify how much money you can save each month, even if it’s only a small amount, then set up an automatic recurring payment so the money automatically moves from your account every month. Best way to do this would be to set up direct deposit from employer this way you never even see the money. Once you have decided in your budget how much you will be investing or saving, do that first because if you wait until the end of the month you might be tempted to spend it on something else!
Paying off debt and investing is hard. If we’re not intentional or trick ourselves into it we may never get around to it. I hope these tips and tricks above will be helpful to you. Comment or email me, I’d love to hear how you’re doing. I’ll answer questions or help anyway I can.