Updated: Aug 5, 2019
Paying off debt and investing are both guaranteed to increase your financial freedom.
However, should you focus on investing while you’ve still got that big credit card balance hanging over your head? Or clear the debt decks and then start on your investing plan?
Here are a few things to consider when making the decision whether to focus on paying off debt or grow your investments.
What Type Of Debt Do You Have?
Not all debt is created equal.
Mortgage debt has a lower interest rate compared consumer debts like credit cards or personal loans. The latter is usually the most expensive form of debt and they’re real roadblocks on your path to wealth creation.
The quicker you can annihilate high interest debt, the sooner you can free up more cash to channel into savings and investments. Every dollar you’re paying back to the bank is a dollar you’ve lost the opportunity to earn interest on.
Consider how long it will take you to pay the debt off. Will it take just a few months to clear that credit card balance? Why not focus all your financial energy for a short period of time to get free of those sky-high interest rates and revolving minimum payments.
Sticking only to the minimum repayment when you can afford to pay off more is never a good idea. Even a relatively small balance of $1000 at 18% interest can hang around for 7 years and cost you almost $900 in interest if you only make the minimum repayment! See for yourself.
It’s a smart decision to focusing on paying back these types of debts first rather than using the money for investing.
Your mortgage is a different story. Even if you aggressively focus on paying off your mortgage, it’s likely to take a lot of time. That's time you could be maximising your investment opportunities too, especially with compound interest.
Do The Math On Long Term Outcomes
Play around with the numbers. Do the interest calculations vs different timelines to figure out the long term results. Doing the math will help you make a decision on what debts to wipe out before investing and when it makes sense to repay debt while investing.
Let’s take a look at the mortgage example. If you put an extra $100 a month towards your repayments on a $400,000 mortgage over 30 years you’d save a little over 30k in interest repayments.
Put $100 a month in a 5% compound interest account with an initial deposit of $1000 and those investments add up to just over $87,000.
This example highlights how in some cases you need to find a balance between debt repayment and investing.
Quick Tips For Paying Off Debt
Ultimately, as long as high-interest debts are weighing you down, your ability to build wealth is seriously limited.
If you’ve decided to go all in and focus on paying off those credit cards and personal loans, here are a few tips for getting it done quickly.
Consider using the ‘snowball’ method and pay back your debts one at a time moving from the smallest to largest balance.
Set a budget. Even if you hate the idea of budgeting, you can find a method that works for you.
Change your mindset about spending and the difference between needs vs wants. Even if you pay off your card, you’ll soon slip back into the red unless your spending habits have truly changed.
Get into the habit of only paying with cash. Swiping a card (even a debit card) can leave you disconnected from how much you actually spend. Cut up the cards and start handing over the notes.
The Bottom Line
Your own financial situation is unique and a blanket set of rules for paying off debt vs investing won’t suit everyone.
We’ve shown you here that in general, a good place to start is paying off high-interest debt as quickly as possible using any funds available. Then shifting gears and focus on boosting your investment portfolio and savings account while still paying down low-interest debts, like your mortgage or student loans.
Where are you at in your financial journey? Paying off debt, investing as much as you can or a little of both? To help ensure that the choice you make is aligned with your long term financial goals, it's always best to speak to a financial planner.
At Create & Protect we take the time to sit with you, understand your financial objectives, lifestyle goals and current situation, then help you articulate a plan that will help you achieve your goals in the future. Get in touch by emailing email@example.com or calling 1300 707 955 today.