Have trouble deciding whether you should be paying off debt vs. investing? It’s easy to pour a lot of your money into investments when you’re debt-free however, it gets complicated when you’re not. The big question a person with debt would have to answer are:
“Do I pay off my debt first before investing?”
“Or, should I pay off some of my debt and then invest some?”
“If I do both, how much of each should I do?”
How to tackle paying off debt vs. investing?
Well, it’s easy if we can break down how much you have extra after we subtract your expenses. It only gets complicated when you don’t know what you’re doing. So to answer your question, we’re going to have to break down your expenses, debt, and how much you have extra.
The Easy Answer
First things first.
You’re going to have to pay your debt no matter what. The simplest way you can do to walk your way to financial freedom is to pay off your debt first before investing. That’s it, all of your extra money should go to your debt payments in order to stop incurring interest.
BUT…
But then, the main reason you’re reading this blog post is that you’re torn if you should invest part of your money first while paying off your debt little by little. And the reason you’re thinking that way is that the interest you’ll earn from some of your investments is higher than the interest you should pay for your debt.
In that case, should you just pay minimum debt and then grow your investments until you’re able to pay your debt in lump sum?
Yes and no.
You see, everyone is different. And any answer is correct as long as you’re able to pay off your debt. A lot of the financial gurus are on either side of the extremes, either pay off your debt first or pay minimum and snowball your investments first in order to pay your debt (or keep your debt to in order to write-off tax).
What most gurus fail to consider is your personality. Different persons will have different risk tolerance. Some are perfectly fine not paying off their debt in a while. Some are not. So here are my answers if I was in the same situation as you.
Emergency Fund
First, have an emergency fund. Forget about investing if you don’t have an emergency fund yet. A good measure of how much you need in your stash is about 3-6 months of your monthly income. That amount is dependent on how volatile your source of income is. So if you have pretty much stable income and your job or hustle is rare, you can be good at 3 months worth of emergency funds. If you’re easily replaceable, be on the safe side and have at least 6 months’ worth on your stash.
Risk Averse
If you’re the type of person who is risk-averse, go and pay off all of your debt first. Risk-averse people do not like the feeling of unease knowing that they have a pile of debt left. It might keep them awake at night thinking how’d they be able to pay off this debt ever. You can think about investments later when everything is already paid off.
Risk Taker
If you’re a risk-taker and think the interest you’re getting from an investment is way higher than the interest on debt, then by all means go and allocate more money in investment over your debt. If you can sleep at night knowing you still have debt and that there’s a chance that your investment might not go according to your plan then go. This strategy will pay off your debt the fastest but of course, if it goes south, you will end up with more debt.
Note: For Investments
Always remember that if the investment return sounds too good to be true, it more likely is a scam. We know so many stories of taking out a loan to invest in the next meme coin in the crypto world to go and skyrocket only to get rug pulled. Never put all of your investments in one basket.
In Between
If you’re neither a risk-taker nor a risk-averse but unsure how to divide how much to pay off your debt vs how much to invest you can simplify this by dividing both your debt payment and investments by 50:50. If you want, adjust the ratio in favor of the one with the higher interest rate.
Summary
Paying off debt vs. investing isn’t that hard to decide. The balance here is first, having emergency funds to help you out if you lose your main source of income. Two, have multiple sources of income to make sure you’ve got yourself extra money to use for paying off debt, investing, or both. Lastly, you’re going to have to choose where to put your money. Your choice should be based on your risk tolerance. A risk-averse person should just pay off debt first before even thinking about investing. A risk-taker in contrast should invest most of his extra money while paying the minimum amount of interest on his debt. Lastly, if you’re in between being risk-averse or a risk-taker, then prioritize putting more money on whichever has a higher interest, your debt, or your investments.
If you’re unsure how to work on getting your income higher, then check out our blog post on how to max out your life.