Investing vs Paying off Debt
Paying off debt. Very often the question is asked, should someone invest while paying off debt? On the surface having debt can be very counterintuitive to investing as the more debt you have the less income you have to put toward investing. However, as usual the answer is not as simple as one might think as it depends on the situation you are currently in.
What is essential to understand is that not all debt is bad and not all debt is prohibitive to investing. High interest debt is the most prohibitive because it is the most expensive to keep long-term. high interest debt robs you of funds you can use to invest thus it would be most beneficial to repay it in fastest possible time before investing.
Types of high interest debt would include
- Demand loans or payday loans
- Credit card debt
- Bank overdraft debt
These mentioned forms of debt have interest rates that can go as high as 30 percent! Having returns on investments that are 6-10 percent will be canceled out. So, the general rule of thumb when making the decision to pay off debt vs investing according to fidelity.com is, compare the interest rate on your debt with the return you expect to earn on your investments. Then put the money toward the option with the higher percentage figure.
This would automatically mean that you should pay off high interest debt such as those listed above as their rates of interest are higher than most investment returns. Lower interest debt such as a mortgage are perfectly fine to keep while investing in other products.
It is also important to note that you should always keep an emergency fund while investing. Unplanned expenses are inevitable. This would shield you from having to withdraw from your investments to fund emergencies. More on how to save for emergencies here.
Making this decision can be a tricky one and its certainly not always straight forward based on everyone’s financial position. So we recommend in your position has too many moving parts please consult with a financial advisor for further advice.