How to manage debt and invest at the same time

To invest or to pay off debt?

If you’ve found yourself wondering whether you should put extra cash toward paying off debt or investing, you are not alone. This is a question that many people wonder about. As with many choices when it comes to personal finance, there’s no one right answer. There are advantages to both strategies.

Choosing to invest or pay down debt will set you up for a healthier financial future than simply spending extra cash you might have on hand. Additionally, this does not have to be an either/or choice. Sometimes it makes sense to work on paying down debt and investing simultaneously. Here’s an overview of some of the advantages of paying off debt and investing.

The basics of debt

There are many different types of debt, from student loans to credit card debt to mortgages. Debt is money that has been borrowed and must be paid back. It’s not a bad thing to have some debt, but it’s important to manage it.

Generally, whoever lent the money charges interest to the person who borrowed it. When interest isn’t paid, there will often be interest charged on unpaid interest. For this reason, it’s a good idea to always make minimum payments on your debt, even if you are deciding to invest instead of paying down your full debt balance.

Advantages of paying off debt

There are a number of reasons why it can make sense to pay down debt instead of investing. Here are a few:

Knock out high interest-rate debt. If you are paying an interest rate on debt that is higher than what you could earn by investing money, it might be a smart move to pay off the debt. For example, if you are paying 25.33% interest on credit card debt, it’s unlikely that you would be able to put extra money toward an investment and earn that percentage return or more back to counteract the interest being charged on your credit card debt. So, in this instance, it would probably be best to knock out the credit card debt before investing.

In contrast, if you have a mortgage with a 4% interest rate, you might be able to find an investment like a stock market index fund that has historically provided a 10% annual return. In that case, investing might be a better move than paying extra money toward the balance on your mortgage. However, it’s important to remember that investing comes with the risk of having one or multiple negative years, which should be factored into your decision.

Improve your credit score. Another benefit of paying down debt is that it will improve your credit score. A better credit score can help you in a number of ways. For example, you may have an easier time applying for other loans, you might be eligible for lower insurance premiums and you’ll likely have an advantage if you apply for an apartment.

Alleviate the stress of being in debt. It’s important to think about your mental health, not just your financial health, when making a decision about investing or paying down debt. If being in debt is keeping you up at night, it might be a good idea to pay off your balance first, and then focus on investing without feeling stressed about your debt. Additionally, paying off debt is usually risk-free, whereas investments always carry some degree of risk. 

The basics of investing

Investing is putting money toward something like a stock, bond, real estate or something else with the intention to increase the value of the money you invested over time.

While not everyone actively invests their money in stocks, many people invest their money passively by contributing to retirement accounts through work, like a 401(k).

Advantages of investing

In some cases, it’s a better idea to put money toward investments instead of completely paying off debt balances. Here’s why: 

Potentially earning higher returns: In general, returns on investments can be higher than interest on debt. However, as mentioned above, this is not always the case, and there is a risk of losing money when investing. Additionally, investments can be volatile. Even though markets have historically trended upward over the long term, your investments might see ups and downs on a day-to-day basis. When investing money, it’s important to think about your risk tolerance and your long- and short-term goals.

For example, if you are saving for retirement and you are in the early stages of your career, it may be more beneficial to put money into higher-risk, higher-reward investments like stocks. At that point in your life, you have more time over the long term to make up potential losses. However, if you’re retiring in the near future, it’s often a better idea to put money into less volatile investments like bonds.

Receiving tax benefits: There are several tax-advantaged ways to invest, especially for retirement. These options include 401(k)s, Roth or traditional IRAs and other investment plans geared toward retirement savings. Generally, paying back most kinds of debt, like credit card debt, does not have tax advantages. However, in some cases, student loan payments or mortgage payments can be tax-deductible, so it may make sense to pay toward these debts if the tax advantages are worth it.

Invest and pay off debt at the same time

For many people, it makes sense to work on paying off debt and investing simultaneously. Finding a balance between achieving these two financial goals looks different for everyone. Focusing too much on investing and neglecting to pay off debts can get you into a situation where you are paying more interest than you need to. At the same time, if you only focus on paying off debt, it can be difficult to meet your financial goals for retirement.

Take some time to evaluate where your debt is coming from and how much interest you are paying on it. Also look at your investment options with regards to the return they are delivering and their risk. Then, make an informed plan for how you want to invest and/or pay down debt. A financial advisor may be able to help you weigh your options and create a plan. A tax professional can explain the various tax consequences. Everyone's situation is different, so you should speak to a tax professional about the right approach for you.

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