Money may not be the key to happiness but it can certainly lead to a more satisfactory life. With a growing bank balance, you can focus your energies on today and not worry about the future. You can provide the best for your family and ensure their financial security during emergencies.
Perhaps this is why choosing between investing and paying off your debt is such a difficult decision to make. There are several emotions at play as it involves a certain degree of risk. Clearing off your debt can ease your stress and leave you with more disposable income. You can use that extra cash to provide a better lifestyle for your family. It will also prepare you better to face economic slowdowns or any temporary loss of income. On the contrary, investing can ensure a comfortable retirement life. You may also have certain aspirations like buying a house, travelling across the globe or buying a swanky new car. Needless to say, investing alone can grow your money and bring you closer to these goals.
Well, the answer is not simple and you may have to adopt a multi-pronged approach to make the most of your money. You need a logical solution that can optimize your finances. Here are a few ways to tackle this situation.
1. Compare your debt’s APR and the rate of return from the investment
This is a simple exercise that can clear your dilemma. The interest rate can help you in selecting the best option for your finances. Most investment options out there will give you a return of up to 7.5 per cent. If your debt APR is more than that, you must consider clearing it off. It all boils down to what give you more returns. Believe it or not, finance guru Warren Buffet has been in a similar situation. He continued repaying his mortgage and decided to invest his money instead. He knew he would make more money in the long run with this choice.
2. Focus on one debt at a time
The situation may be more challenging if you carry more than one debt like credit card debt, student loans etc. In this case, it is advisable to first clear off your debt with the highest APR. If it is higher than 10%, you may choose to make it your financial priority for the time being. The interest rate will keep accumulating and only increase your financial obligations. It is also a good idea to use any extra income or bonus or windfall to clear off this loan as soon as possible.
3. Pay your credit card debt
If there is a menacing debt, it is this. Credit cards almost always come with high-interest rates. In some cases, the rate can even exceed 20%. Credit card dues require you to give minimal payments initially and this is the exact reason why they can be so dangerous. They can escalate to exorbitant levels in no time and put you under debt for a long, long time. It is for this reason that most financial planners will encourage you to clear your credit card debt before you invest your money elsewhere.
4. Clear off all your debt
Money management is personal. This is the reason that one solution may not be the perfect choice for everyone. If you think you can sleep well at night knowing there is no debt over you, it may be wise to clear it all before you start investing.
Here are some other guidelines that you may follow if you are confused about which debts to repay and where to invest your money.
1. Fund your retirement fund such as 401(K). You must match your employer’s contribution and make the most of this benefit. You can continue doing so even if you have credit card debt looming over you.
2. Put aside some money in a liquid savings account as your emergency fund. You must have at least three months’ worth of your income to handle any personal emergencies.
3. Maximize your tax savings by investing in Roth IRA. Of course, first, you will have to check the eligibility guidelines and the contribution limit.
4. Pay off all the high-interest rate debts like credit card debt, student loans etc.
Since financial decisions are emotional, it advisable to select a strategy after careful deliberation. Choose a path that will keep you happy in the long run.