If, for some reason, you have come into extra money, it may be difficult to decide what to do with it. Some consumers wonder whether they should pay down their debts or invest the extra money towards their financial security.
Both options are valid to consider, but depending on a person’s circumstances, one choice might be better than the other.
Investing Extra Money
When a person invests money, they’re setting it aside but doing so in a beneficial way. Investments grow over time, making them different from a standard savings account, and they become mutual funds. Savings can grow in interest, but true investments are intended to generate some form of income.
Investments are a good idea if you’re planning for individual retirement savings, emergency fund, college preparation for your children (educational purposes), or starting a business.
Some popular investment routes to consider are stock market, bonds, CDs, or municipal debt. CDs and U.S. Treasury debt is determined to be the safest investment type. Stocks and bonds are quite a bit riskier with higher rates of return.
When Is It a Good Idea To Invest?
When trying to determine the right step, every situation is different. Before making a choice, take a look at the after-tax interest rate of your debts. Compare that rate with the ROI rate of the investment you’re considering. If the return on investment is higher, invest the money. If the interest rate is higher, you’ll want to prioritize paying off your monthly debt payment.
The end goal should be to put your extra money toward its best use. If you can still make your minimum monthly payments toward your debt and afford to invest, do so. If you’re finding that your debt is becoming difficult to manage, you may want to reduce the debt as soon as possible.
If you plan to invest money into a nest egg, it’s best to speak with a professional advisor about investment advice. This way, you can develop an investment strategy that suits your individual needs and can prepare you for the future. You can also talk to them about financial advice.
The Considerations
Before deciding whether to invest extra money, a consumer should consider their financial goals. Should the person be investing in a retirement plan? For college education? A family vacation? Emergency fund for an unexpected expense? If a person’s goals are not clear, they may not know where to start.
If the goal is retirement, it may be best to start by looking at what expenses the consumer has now and needs in the future. It may be better to look at investment options that will provide cash flow now, but have the potential return in the future. These investment options might include stocks or bonds. Other options might include an annuity or some other type of long-term savings plan.
Another consideration is how much extra money is available for investment. Some consumers have more money than they need, while others may have less than they need for certain goals. It may be better to save a little each month if it will result in more money when needed for retirement or other purposes later on. It can also be helpful to keep track of living expenses and look at ways to cut back so that more money can be saved or invested each month.
Paying Off Debt
Not all debts are created equal, meaning that there are kinds of debt that come standard with everyday life (mortgages, car loans, federal student loans, personal loans, etc.) and there are debts that can be troublesome if they’re not paid off quickly and affect your excellent credit score.
Mortgage debt is normal, and the interest paid each year can be deducted when you file taxes. It’s not ideal to spend decades paying off a home, but it’s common.
Debt brought on by bank credit cards or medical care is a different story. It’s easy to become overwhelmed when you didn’t anticipate owing so much money. Whether you incurred too much credit card debt or have an emergency medical need, these debts can easily get out of hand.
With credit card debt, high-interest rates can cause consumers to owe significantly more than they’ve spent. Each month, the interest rate is added to the balance whether you have made purchases or not. When debt like this becomes difficult to manage, it needs to be dealt with as soon as possible.
When Is It a Good Idea To Pay Off Debt?
In many cases, the interest rate on significant debt will be higher than most investment returns. In these situations, it would be most beneficial to try a debt payment. By doing so, you can get ahead of it and manage what you owe before it gets out of control.
While there are several other endeavors you’d like to put your money towards, paying off debt or making payments on time is a reasonable choice. Once the debt is paid off or lowered significantly, it can allow your income to stretch farther each month. This will open more financial opportunities in the future.
When Debt Interferes with Savings
If you’re unsure whether paying off your debt is more reasonable than investing, take a look at your checking or savings account. Most financial advisors will suggest that individuals keep enough money saved to cover at least six months of expenses. This is called a “safety cushion.”
However, many working-class individuals can’t put this much money away because their debt is too high. Being unable to save usually means that paying off debts should become more of a priority than investment.
Once you can lower your debt-to-income ratio to where debts take up no more than 33% of your income, you can start putting money towards your safety cushion. Once you have a safety cushion, it’s a good time to start investment planning.
Whether you’re planning to pay off your debts or invest your extra money into a nest egg, it’s a good idea to talk to financial professionals to get a better idea about your plan. These individuals can offer valuable advice that will help you put your money to its best use. By making smart financial decisions, you can better prepare for your financial future and ensure that you’re better protected from financial hardships.
The Considerations
It may be easier to decide whether to pay down debt or invest extra money if a person has a clear idea of what debts they currently have and need to pay off. The more obvious the debt, is the easier it will be to make a decision.
Consumers should also consider the amount of interest that is being paid on the debt. Interest is often paid monthly and costs money, so it can add up quickly. If a consumer does not want to pay more interest than necessary, it may be better to pay down the debt instead of investing extra money. It can also be helpful to know how much interest is being paid on different types of debt and how much additional interest would be paid if the debts were rolled over into another type of loan.
When it comes to paying off debts, it’s a good idea to know what you have and then decide which debts you can pay off first. Some consumers have high-interest debt that only makes them more. If you are struggling with credit card debt, you may want to consider a debt consolidation loan to get your financial situation under control. If your car payment is too high, the extra money might be better spent on fixing the vehicle rather than paying off the credit card.
The first step in deciding whether to pay down your debts is determining how much money you have coming in each month. If you can afford to pay more toward your debts, this could be a good time to refinance or consolidate your loans. On the other hand, if there is little extra cash or spare cash coming in each month, paying down debt may not be an option for you at this time.
Finally, a consumer should consider whether they have enough extra money available for investing without having to use some of their available cash flow for other purposes. This can help determine whether it is better to pay down debt or invest extra money to have better financial moves and get the biggest benefits.
