Should You Pay Off Debt Before Investing?

It’s truly a quandary: you want to start investing, but you’ve got more than a little debt to take care of. You feel like you should clear those obligations first, except you’re not sure how long that would take. You don’t want to make excuses, but really, should you pay off debt before investing?

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Well, let us look.

Interest Rate

There’s a prevailing school of thought that basically posits that, when comparing the interest rate on your debt with what you expect from your investments, you should put your cash into the one with the highest percentage.

While that sounds totally reasonable in principle, there’s one problem: it’s difficult to anticipate return rates. Thus, it usually is wiser to first get rid of any debt that has an interest rate of 6 percent or more. There’s a big caveat here, though: You should have at least a decade’s worth of retirement funds stashed away, your portfolio should be 50 percent in stocks, and you should have an IRA or 401(K).

On the other hand, if the interest rate on your debt is under 6 percent, you should likely go ahead and invest. Why? Because your chances are better than, at lower rates, your investment returns over time will top the rewards of erasing debt quicker.

Other Factors

Having said all that, there are a few things you should make sure are taken care of before even mulling the debt vs. investment question. Namely, you should first be paying the minimum, at least, on all debts. What’s more, you should make sure you have an emergency fund – six months’ worth of expenses is ideal – and a spiffed-up credit report. You also want to take advantage of any employer matches on retirement savings, and any credit card debt should be taken care of. If you need help with the latter, we suggest you contact the leading debt settlement agency Freedom Debt Relief.

Understanding Investing

Before putting together a stout investment strategy, do you even know the basics of investing? Well, it’s paramount that you do.

The first thing you should understand is that while you can certainly make money over the long haul by investing, the practice is still risky. However, if you are going to invest, the guidelines for optimal results include investing early, reinvesting your earnings, and having a diversified portfolio.

The fact, though, is that younger people aren’t as interested in investing as their parents. A Gallup poll found that just 37 percent of individuals under age 35 currently invest in the stock market. That’s a significant reduction from the 52 percent before 2008.

Types of Investments

If you’re ready to invest, you may want to enlist the help of a financial advisor to help you determine which investments fit your financial goals. Having said that, here are the most common types of investments:

  • Stocks. Purchasing stock means purchasing an ownership stake in a publicly-traded organization.
  • Bonds. Here, you’re basically lending money to a business or government entity.
  • Mutual funds. This is a pool of many investors’ cash that’s invested in many different companies.
  • Exchange-traded funds. These comprise a collection of investments that track a market index. Shares are bought and unloaded on the stock markets.
  • Certificates of deposit. This is a low-risk investment in which you give a banking institution a specific amount of cash over a fixed time length.
  • Retirement plans. This encompasses workplace retirement plans such as 401(k) and 403(b), as well as plans you get on your own: an IRA or a Roth.
  • Options. This is a bit more complicated way to purchase a stock. Essentially, when you purchase an option, you’re buying the ability to purchase or unload an asset at a particular price at a given time.

So, should you pay off debt before investing? It depends on several factors, including the rate you’re paying on your obligations and whether you’ve first paid off your credit cards, captured any employer match, and stashed away emergency savings. Once all that’s taken care of, you can think about investing.

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