There are lots of things you know you should do with your money. But it can be hard to know what to focus on first. Investing can help you build wealth and create a comfortable retirement. On the other hand, debt can hinder your financial capabilities today and has a significant long-term cost.
As a general rule, it's best to balance investing and paying off debt. But sometimes, it makes sense to prioritize one over the other. Which financial goal you should focus on first depends on your unique financial position. Consider these things to determine your best strategy.
Read more: I Can Retire Early After Paying Off $300,000 in Debt. Here's How I Did It
You should focus on investing if…
It could be wise to concentrate on investing in the following scenarios.
📈 Your investments earn more than you're losing to interest charges
"The most basic consideration is comparing the return on your investments versus the interest you're paying on your debt," said George McFarlane, president of 7 Waters Advisors. If you're paying less interest than the return you're earning from your investments, you should focus on investing rather than paying off debt. "This strategy allows you to offset the interest you're paying and potentially achieve a net gain," McFarlane said.
For example, say you pay 5% interest on your mortgage and your investment portfolio generates 8% in annual returns. In this case, you may want to focus on investing since your investments produce a 3% net gain.
⚠️ You have a low risk tolerance
If you have a low risk tolerance, it's important to start investing as soon as possible to take advantage of long-term compound gains. Low-risk investment assets like CDs, bonds and dividend stocks offer slow and steady growth but take some time to produce meaningful gains.
💰 Your company offers a retirement plan match
If your employer matches your retirement plan contributions, focusing on investing could have a big payoff. For example, say your employer matches 100% of your retirement contributions up to 3% of your income. If you make $100,000, that means they'd add $3,000 to your retirement fund. That's essentially free money.
Tips to invest wisely
You should consult an investment professional to create the best investment strategy for you. However, these general tips are worth keeping in mind.
- Build a diversified portfolio. Diversification means spreading your investment risk across multiple assets. This way, if some assets in your portfolio lose value, other assets' gains protect your portfolio as a whole. "Non-diversified investments are higher risk because they're vulnerable to market swings, which can make them susceptible to larger losses," said Alex Blackwood, CEO and co-founder of Mogul Club.
- Know your risk tolerance. Your risk tolerance can help you determine your asset allocation. For example, younger investors with a high risk tolerance may allocate more of their funds to stocks because they have more time to recover from losses. Investors nearing retirement should allocate more to safe havens like CDs, which don't have as much growth potential but offer much more security.
- Do your research. When you invest in a company, you become a partial owner of that company -- sharing not only the gains it produces but also the losses. Take the time to fully understand what you're investing in before you risk your capital.
- When in doubt, consider index funds. If you're not sure where to start, consider investing in index funds. These are highly diversified funds that give you exposure to every asset in the index they represent. For example, if you purchase an S&P 500 index fund, you'll gain diversified exposure to one of the most followed US stock market indexes.
You should focus on paying off debt if…
Here are some times when paying off your debt should be your top priority.
💸 Your interest charges cost more than your investments are earning
"If you're carrying high-interest debt, such as credit card debt at 15% or more, your best investment is to pay off that debt first," McFarlane said.
When you have high-interest debt, it can be difficult to find investments that will reliably produce gains greater than the interest you're paying. You'll be better served by working to get rid of your high-interest debt before you start investing.
🎯 You want to improve your credit score
Your credit score often dictates your ability to get loans and the fees and interest you'll pay when you do. But that's not all. Your credit score can also affect your ability to access affordable housing, and a poor score may even hinder you from getting the job you're hoping to land.
If you have poor or fair credit, there's a high likelihood you have debt that needs to be addressed. Paying off that debt could help you improve your credit score, setting the foundation for your financial stability.
😟 Your debts cause you significant stress
Debt can be stressful. That's especially true when you consider today's high cost of goods and housing. If you have a significant amount of debt, you may be forced to make sacrifices in order to make your monthly payments. If that's the case, you should focus on getting out of debt before allocating your funds to investing.
📊 You have varying income
If your income fluctuates from month to month, it may be best to focus on paying off your debt when you have extra income. Once you get out of debt, you can use that extra income to invest in your future.
Tips for paying off debt
Get out of debt quickly with these tips.
- Choose a repayment strategy. There are multiple payment approaches to choose from. Two of the most popular are the debt snowball and the debt avalanche. Both involve paying minimum payments to all but one of your accounts. With the debt snowball method, you put any extra funds toward the account with the largest balance. With the debt avalanche, you put extra funds toward the account with the highest interest rate. Once the first account is paid off, you put extra funds toward the next account in line and so on, until your debt is completely paid off.
- Use a balance transfer card. Balance transfer credit cards allow you to transfer the balance from other, higher-interest accounts. They often come with promotional interest rates for a predetermined time -- like 0% APR for 12 months. Consider using one of these accounts to pay off your high-interest debts. But be mindful of the standard interest rate. You'll pay that rate on any remaining balance once the promotional period expires.
- Consider debt counseling. If your debt is overwhelming, it may be best to seek assistance. Nonprofit credit counseling companies can help you get on track by negotiating more affordable payments and lower interest rates. However, be picky when choosing a provider. Some debt relief companies are for-profit and charge exorbitant fees, and some programs may have a detrimental impact on your credit score. You can find a certified nonprofit credit counselor through the National Foundation for Credit Counseling.
The best approach is a balanced one
While some circumstances justify focusing on investing or paying off debt, most people should take a balanced approach. The key is taking your entire financial picture into account and coming up with a strategy that works for your situation. A financial professional can help you create the plan that's best for you.
