Should I Pay Off Debt or Invest Extra Cash?

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 toward their financial futures.

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. 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 retirement, college preparation for your children, or starting a business.

Some popular investment routes to consider are stocks, bonds, CDs, or municipal debt. CDs and U.S. Treasury debt are determined to be the safest investment type. Stocks and bonds are quite a bit riskier.

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 investment return is higher, invest the money. If the interest rate is higher, you’ll want to prioritize paying off your debts.

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. This way, you can develop an investment plan that suits your individual needs and can prepare you for the future.

Paying Off Debt

Not all debts are created equal, meaning that there are debts that come standard with everyday life (mortgages, car loans, etc.) and there are debts that can be troublesome if they’re not paid off quickly. 

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 credit card 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 had 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 adds 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 will be most beneficial to try paying off the debt. 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 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.