According to Federal Reserve statistics and other US government data, the average US household credit card debt is $15,706; average mortgage debt $156,333, and average student loan debt $32,953. Is it reasonable to pay off debt or invest instead?
Whether you are single or have a family, we all want to manage our finances well. Many of us still have some debt as well, such as mortgage, student loan or even credit card debt. Having a debt can cause many sleepless nights while you are constantly trying to think how to dig yourself out of it.
Since you are hard-working and have managed to save pretty decent amount, what should you do with that money? How to make the best financial decision? Which is better, to pay off debt or invest?
There really is no right or wrong answer. It depends on your current financial situation.
These top 5 tips help you to make the wise decision whether to pay off debt or invest instead.
Top 5 Tips that Help You Decide Whether to Pay Off Debt or Invest Instead
Tip # 1 Look at the numbers
Step 1: If you are thinking about investing your money, you need to calculate the after-tax return of investment.
Step 2: Get clear how much interest are you really paying. You would need to organize all of your debt accounts based on the interest rates you are currently paying. It helps you to understand which debt is most expensive (you definitely do not want to keep paying interest that is higher than 9-10%, so try to pay it off fast!).
Step 3: Compare the numbers. If your after-tax interest number is greater than you could potentially earn from your (after-tax) investment, you should pay off your debt instead.
Tip # 2 Use a calculator
Another way to figure out whether it is better to pay off debt or invest, is to use a CalcXML calculator or MyFICO calcualtor. It is free and can be somewhat helpful. You will get an instant result based on your personal financial situation.
However, never make a final decision just based on calculators. Use those as helpful tools that give you a better understanding of your financial situation. Besides, be aware that investing typically involves fees as well.
Tip # 3 Don’t forget your credit score
You really need to have a very clear overview of your debt. If you have a credit card debt, you need to make sure you make your payments on time, and don’t use more than 30% of your credit limit. Ideally you should only use it up to 10%.
Remaining a good credit and improving it should be one of your priorities as well. Therefore it is reasonable to pay off your debt first if you have trouble making monthly payments or use more than 30% of total credit limit.
Tip # 4 Maximize your 401(k)
Investing or paying off debt are both winning situations. Depending on your financial situation, it might be wise to maximize your 401(k). Consider taking advantage of your employer’s matching contribution. However, you need to figure out what is the most beneficial situation for you, because employers often contribute differently.
Do your research and take advantage of this “free money.” Learn the details of maximizing your employer’s 401(k) contribution.
Tip # 5 Consider opening a 529 plan
If you are interested in investing, you need to know your risk tolerance. Are you very conservative or ready to take higher risks? Be aware of unexpected circumstances such as losing an income, accidents, deaths, divorces just to name for few. Make sure you have sufficient emergency fund as well.
Consider opening a 529 plan for your children. It is important to note that 529 plans offer tax benefits based on states, and are therefore great options. However, you have to be smart which plan is right for your family. Should you pick college savings plan or prepaid tuition plan instead?
Sometimes your employee benefits include a free consultation with a 529 plan consultant or a financial advisor. This could be very helpful to find out whether it is better to pay off debt or invest into 529 plan.
Wrap up: Is It Wiser to Pay Off Debt or Invest?
There is no right or wrong answer to this question. It depends on your current financial situation and your (financial) goals. Not every debt is bad, such as mortgage with a good interest rate. It might be reasonable to invest if you have a good credit score and your return of investment is higher than the interest of you are paying.
Whether you pay off your debt faster or decide to invest instead, you will win either way.
What is your opinion or experience? Which do you prefer – to pay off debt or invest instead? Share your thoughts below!
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