Is It Better To Pay Off Debt Or Invest With Your Extra Money

Do you remember when you were a kid? There was no such thing as extra money…. there was never enough of the stuff! However, as we grow older, we start to realize the real meaning of extra money. This is money that’s left over after the bills are paid and spending money is budgeted in. It’s the money that we use to save for retirement or pay off debt. The problem is figuring out which to focus on first! Today, we’ll talk about whether it’s better to pay off debt or invest in your retirement first.

Understanding Opportunity Cost

At the end of the day, just about everything comes with an opportunity cost. When you spend the time or money doing something, that time or money could have been used elsewhere. The difference in the reward is your opportunity cost. This is a big part of choosing whether you’re going to pay off debt or invest with your extra money.

At the end of the day, the goal is to make your money work as hard as it can for you. In order to do so, you have to pay attention to earnings and losses. For example, just about every loan will come with interest payments, these are your losses. Investments will generally come with earnings, these are your gains. To decide if it’s better to pay your debt off or invest first, you need to take a look at what you’re losing on your debts, and what you stand to gain on investments.

Making A Plan Based On What You Have To Lose And What You Have To Gain

In order to make your plan, you’re going to need to make a couple of lists…

• List Your Debts – The first list is a list of your debts. This should include all secured and unsecured loans you have. For example personal loans, credit cards, car loans, mortgages, and any other loan should be included in the list. When listing these, make sure to list the amount owed and the interest charged.
• Figuring Out Investment Gains – If you’re already investing, you’re one step ahead. You know how much money your investments are making for you. Figure out what percentage your return was over the past year. If you’re not already investing, start researching different investment vehicles and consider getting in touch with a financial advisor. After doing your research, you should have a good idea of what percentage return you stand the chance of earning when you invest. In most cases, you’ll come to a figure around 7%.

Once you have these two lists, it’s time to make your plan. The idea here is that if you’re making more money investing than you are paying to borrow, you’re in a good place. So, any loans that cost you more money than you are making in the market should be paid off as quickly as possible.

With that said, your highest interest rate debts should be written in your plan as the debts to pay off first. All extra money should be paid to the highest interest rate debt until it is paid off. From there, go to your next highest.

Once your high interest debt is paid, and you’re making more money investing than you’re losing on interest with the rest of your debts, it’s time to change your strategy. At this point, the gains on your investments pay the interest on your debts and may even still yield a profit. So, once you get to this point, it’s best to pay minimum payments on your debts and invest your extra money. This is where your money is going to work hardest for you.

Final Thoughts

As a personal finance and investing expert, I can’t tell you how many times I’ve been asked if it’s better to pay off debt or invest for your retirement first. Usually, the answer is mixed. At the end of the day, the answer to this question largely depends on how much money you’re paying in interest and how much money you’re making on your investments. However, by following the guide laid out above, you should be able to find your answer in no time!