Should I Pay Off Debt or Invest First?
Table of Contents
Ah, the age-old question. Should you pay off debt or invest first? There tend to be two camps at the extreme ends of these ideas. And let me tell you, sometimes people can get a little crazy.
Lucky for you I have used both approaches and am here to share what I have learned! That way, you can see which camp you fall into to make the best choice for your own personal situation. And the great thing? Even if you start paying off debt first or vice versa and then decide maybe that wasn’t the best for you, you can always change your mind at any time!
Our Experience with Debt Pay Off
To start here is a bit of background on Joel and me. We got married right after college and had around $40,000 of student loans. While I went to grad school for 2 years, we paid the minimum on those loans. Then, we bought a new vehicle and ended up with another $20,000 in debt.
All in all, we had around $60,000 in debt when we decided to get serious about aggressively it off. I had just started working and so with 2 incomes and living frugally, we were able to pay off all that debt in just under 2 years!
Becoming debt-free at 25 years old felt AMAZING and liberating. It was like a weight lifted off my shoulders.
P.S. It will still feel great to have been out of debt many years sooner even if the next president provides some kind of mass debt elimination. Although it would be kind of annoying. Definitely something to keep in mind in the short-term at least.
Our Experience with Investing
Well, we were debt-free for all of a couple of months before we decided to do something really crazy.
We made the choice to buy a used RV so that I could become a traveling SLP. We initially took out a $45,000 loan for the RV and then immediately paid off $11,000 of that using money we had been saving for a house.
I mean, I guess it technically went towards a house right?
So anyway, we were back in debt. We still worked hard to bring down the principal quicker than we had to, but we were more focused on investing this time around. Over about 6 months, with the extra money I began earning as a traveling SLP, we got the RV loan down to around $15,000 but this is when we stopped being so aggressive in our payoff.
The interest rate on our RV loan isn’t too high. Because of this, we have been paying the minimum balance for the last several months to really focus on investing. We hope to retire well before we turn 65. So, investing early and as much as possible has been a key focus since paying off our student loans.
Now that you’ve got a bit of an idea about how we came to be in each of the two different camps at different points in our financial journey, I’m going to jump into the pros of each option. The main con of each is kind of just that you miss out on the pros of the other options.
It isn’t up to me to tell you what is right for you. But by getting an idea of the benefits of each option, I hope you’ll be able to feel confident in whatever decision you make!
Pros of Paying off Debt First
As someone who was once loaded down with debt, I can tell you, it is not a good feeling. At least it wasn’t for me. The thing is, money is EMOTIONAL. You can talk dollars and cents all you want, but what people can’t measure objectively is how having debt makes one feel.
Some people aren’t bothered by things like student loans. They have decided the fact that investment returns will outpace loan interest (in most situations) means they should invest first and pay the minimums on their loans.
Oh to have a brain like that. My brain, on the other hand, likes to worry about the worst-case scenario. What if something terrible happens like losing a job and suddenly we find ourselves unable to pay our loans?! If you’ve got anxiety, you probably know exactly what I’m talking about. If you don’t, consider yourself blessed!
As time has gone on and I’ve gotten more confident and worked through some of those feelings, I’ve been able to look at things more objectively. Hence the investing which we’ll get to soon.
Here are the best things about paying off debt quickly vs investing.
- FREEDOM. You don’t have to deal with the emotional burden that debt can lead to. You also don’t have to stress out about making your loan payments every month and what would happen in a financial emergency.
- Extra money in the budget once you’re debt-free. Once you don’t have to pay hundreds or thousands of dollars towards debt every month, you will have a lot more flexibility in your budget. You will have gotten used to living without this money which means you can use it to help you reach important goals. Maybe you start to direct money towards things like investing, saving for a house, saving up to have your first kid, or dare I say purchase an RV and live the life of a wanderer?
- No more paying extra money for interest. If you pay off your debt more quickly you will end up paying significantly less in interest. That is a guaranteed return on your money! After hearing stories of people who ended up paying thousands of dollars towards loans only to owe MORE than they borrowed after paying on their loans for YEARS I just couldn’t stomach that possibility.
- Improve your credit score. When you have a lower debt to income ratio your credit rate tends to go up. This will help with things like getting a mortgage someday. Additionally, sometimes employers or landlords will even check your credit score so it is a good idea to keep on top of that number.
- Better relationships. Money tends to stress people out, especially in committed relationships. I have heard so many stories of people who aren’t on the same page financially as their partner. Eliminating debt can help reduce a significant source of money stress and help strengthen your relationship and reduce fighting.
- Being able to help others. Once we knocked out our car loan and student loans, we were able to also increase our charitable contributions. Because it is important for us to give back, we had been doing so even while paying off our loans. But once they were gone, we were able to be more generous without feeling stressed. It allowed me especially to feel like a more cheerful giver.
Pros of Investing Early
There are also many benefits to investing early and consistently. It can feel easy to think of retirement as being some far off thing that you don’t need to worry about yet. And unfortunately, many Americans do just that.
But just because everyone is doing it (or in this case not doing it) doesn’t mean it is a great choice. Millions of Americans aren’t going to be properly prepared for retirement because they didn’t commit to saving for their own future.
Don’t let that be you. Here are some great reasons why investing earlier might be better than quickly paying off your debt.
- More time for compound interest. This is a HUGE one. The sooner you start building your nest egg, the sooner you can start to reap the benefits of compound interest. Did you know that the majority of your retirement money will come not from contributions but from interest earned on those contributions? The more time you have to earn interest the more you’ll have at retirement. I love looking at this retirement calculator which gives such a great visual of just how big of a deal compound interest is!
- Did somebody say early retirement? The FIRE movement, which stands for financial independence retire early has been gaining momentum recently. People are sick of working until they are 65 only to have just a few good years left to enjoy the fruits of their labor. If you start investing early you have a much better chance of being able to retire early as well.
- Develop discipline to plan for the future. The earlier you start investing, the sooner you can start to develop the discipline needed for consistency. Consistent investing whether the market is up or down (dollar-cost averaging) is almost always better than trying to time the market.
- Early mistakes or losses won’t impact you as significantly. If you make a bad investment decision or the stock market takes a major hit, you will have time to recover if you start investing earlier. You will continue to learn the more you read and research and that will allow you to make smarter investment choices as time goes on. If you wait to start investing until later in life and make a similar mistake, time is no longer on your side and you may end up having to delay retirement. Not fun!
- Ability to take more risks and (hopefully!) earn higher returns. This one goes right along with number 4. If you start investing at a young age, you can afford to take more risks and be more aggressive in your portfolio. Being more aggressive when you’re young means there is a possibility for higher returns. As you near retirement age the risk associated with your portfolio should go down. This is because you don’t have that time needed to recover from drops in riskier investments like you would if you invest early.
So, Pay Off Debt or Invest?
Everyone’s financial and personal situations are different. While the numbers may say one thing, the numbers plus emotions may lead to a different conclusion. The bottom line is this. Aggressively paying off debt will always help in terms of less interest paid. It may also significantly reduce your stress and may also increase the risk you feel comfortable taking with your investments.
On the other hand, the earlier you start investing for retirement, the more money you will have at retirement. Time is your best friend when planning for retirement because compound interest will significantly increase the value of your investments. And the market returns (that is how much the value of your stocks will go up) will almost always exceed interest rates on most student loans and mortgages. If you have high- interest debt, that’s another story.
Regardless of which route you choose to take, you can feel confident that either option is going to significantly improve your financial future. And if you change your mind down the road, that’s ok, you can always change your tactics like I did!
0 Comments