Pay Off Debt Or Invest Your Money?
December 9, 2008
If you come into some extra money suddenly, whether through a pay raise, an inheritance or some other method, does it make more sense to pay off debt or to invest that money?
At its core, this question comes down to a rather simple determination:
Can you earn more interest by investing it than you are paying on the debt?
By paying off your debt, you’re effectively “earning” whatever interest rate you’re paying. Because you no longer have to pay that interest, the money you put towards the debt has earned a guaranteed interest rate. If you can’t invest the money to earn more than that, it doesn’t make sense to save it while continuing to pay interest on the outstanding debt.
Let’s take a look at a couple of options…
First, if your debt is on credit cards there is really no question - pay off the debt. There are no low-risk investments that will pay you more interest than you are paying on the credit cards. Some high-risk investments might but being high-risk means you could also lose money (potentially all of it).
That’s not a good gamble to take when you still have all that debt.
Next, if your debt is in lower interest loans, like student loans for example, you might be able to earn more interest than you are paying. But it’s going to depend on your investment skills and how interested you are in “watching the market”.
Whether you invested in the stock market or something else, you need to keep an eye on those investments to make sure they continue to earn more than what your debt is costing you.
One possible advantage you have here is that some of the interest you’re paying could potentially be tax deductible. Student loans and mortgages are deductible in some cases, for example.
If you can claim the interest on your tax return, you might even come out ahead if your investment earns a little less than what you’re paying for your debt. This is something you would want to discuss with a tax advisor before making any decisions.
Something you should do no matter what you decide to do with most of the money is save an emergency fund if you don’t have one already.
This could be a small fund - $1000 to $1500 let’s say - for unexpected emergencies like car or home repairs. Or it could be a larger amount, such as 3 to 6 months of living expenses in case you lose your job unexpectedly.
How much you should save will depend on several factors:
- How much money you have to work with
- How stable your job is (although it’s hard to really know for sure these days)
- How much debt you have, and how much of it is high-interest consumer debt like credit cards
In the end, there are times when you’ll get better results by investing your money and keeping the debt but in most cases the opposite will be true.
Comments
One Response to “Pay Off Debt Or Invest Your Money?”
Got something to say?
Sponsors
At least having a small fund is something I agree with.
You just never know. And it’s proven true in today’s market. A small EF fund or some savings can go a long way to mental peace.
Fabulously Broke in the City
Just a girl trying to find a balance between being a Shopaholic and a Saver…