Paying Off Your Debt or Investing: Which Is Best?

Apr 8, 2020

[vc_row][vc_column][vc_column_text]paying off your debt or investing

 

Are you torn between paying off your debt or investing? As you consider your golden years, you might be asking yourself, “How do I balance paying off my debt, saving, and investing in retirement?

Whether you’re decades away from retirement or it is quickly approaching, you should strike a balance between paying off debt and investing. As you find a mix that works for you, you should keep your current and future financial needs in mind. However, it can be difficult to know what the best decision is for your needs. Here are a few suggestions for juggling paying off debt and investing.

 

Prioritize your retirement savings

Saving for your retirement should take precedence over your other financial goals. Even if you can only contribute a small amount, contributing toward your retirement accounts can help you capitalize on compound interest, which will help your money grow over time.

If your employer offers a company-sponsored retirement plan, a 401(k) plan is a great place to start saving for retirement. You can contribute up to $19,500 of your pre-tax income for 2020. If you’re 50 or older, you can contribute up to $26,000.

Some companies also offer a match program. With a match program, companies will offer a match percentage up to a certain amount when employees contribute to their plan. For example, your company may offer a 100% match up to 3% of your total contribution. So, if you contribute 3% of your earnings to your 401(k) your company will give you another 3%. This means that your 401(k) contribution will total 6% of your income but only 3% comes out of your paycheck.  Essentially, you’re getting free money for saving for retirement.

If you work for a company that doesn’t have a retirement plan, you may want to consider opening an IRA or Roth IRA. Your financial planner can help you open an IRA. You can contribute up to $6,000 in 2020 ($7,000 if you’re 50 or older). Speak with your financial planner to determine which IRA is right for you.

 

Get rid of toxic debt

While everyone has a unique financial situation, experts suggest balancing your funds between paying down toxic debt (high-interest debt) while continuing to contribute toward your retirement savings.

If you have a credit card, payday loan, or other accounts with variable or high interest rates (anything above 9%) you should tackle this financial goal next. High-interest debt chips away at your savings and future financial security. Therefore, it’s important to get rid of it as soon as possible.

One of the most common strategies to get rid of high-interest debt is the avalanche method. With the avalanche method, you will write down all your revolving debt balances in order of highest interest rate to the lowest interest rate. Then, while paying the minimum payments on all your other balances, you will contribute any extra cash you receive toward your highest interest rate balance until it’s paid off. Once you repay this balance in full, you will move on to the next highest interest rate balance and so on. You will continue this process until all your debt is repaid.

Not only will this strategy rid you of your high-interest rate debt for good, but it will save you money in the long run since you are tackling your highest interest rate balances first.

 

Contribute to an emergency fund

Your third priority should be an emergency fund. Financial professionals recommend having at least three to six months of your expenses saved in case of an emergency. Emergency funds are designed to protect you from financial distress in case an emergency expense arises. These expenses could include car repairs or help to support your lifestyle in case you were to lose your job.

Creating an emergency fund will help you protect your assets and give you peace of mind when accidents occur. If you don’t have one already, it’s wise to start building your rainy-day fund immediately. Keep in mind, it’s okay to start small. This will help you avoid going into credit card debt when an unexpected expense occurs.

 

Turn your attention to low-interest debt

After you have gotten rid of your toxic debt and started a solid emergency fund, try turning your attention to your lower-rate interest obligations. Your lower-rate interest debt may include your student loans or mortgage.

Another debt repayment strategy is the snowball method. With this debt repayment strategy, you prioritize paying off your smallest debt balances first, while making the minimum payments on your other debt balances. Once your smallest balance is repaid, you can move on to the next smallest balance.  The idea here is that eliminating debt is exciting, and this excitement will help sustain motivation when tackling larger debts.

 

Follow a written plan

The next step toward becoming debt-free and saving for retirement is to create a written plan. You should consult with your financial planner to help you establish a plan that will keep you on the path toward achieving your financial goals.

Your financial planner or advisor can help you identify your financial goals and create a step-by-step process for how to achieve them. This plan may include all your monthly or bi-weekly payments laid out so that you know exactly how long it will take to pay down your high and low-interest debt. It will also reflect your retirement contributions and emergency fund contributions so that you have a good understanding of your overall financial situation.

 

Review and adjust regularly

By reviewing this plan with a professional, you will be able to review it often and check for any issues. For example, if you have a setback one month, they will be able to help you adjust the plan. If you’re ahead of budget or receive a bonus, they will be able to help you contribute your extra money to the most advantageous area of your budget.

It is important to note that your financial goals may change over time. You may grow your family or choose to downsize your home. You may earn more income later in your career, or you may have a spouse that chooses to stay home. When you have a written plan, clear goals, and a professional to help hold you accountable, these financial situations will be much easier to navigate.

 

The bottom line

So, paying off your debt or investing, which one is better? While every person’s finances are unique, we strongly advise prioritizing your retirement. Do not leave any free money from an employer on the table. Once you have set up a retirement account, pay off your high-interest debt as fast as you can. Those payments will help you to avoid paying unnecessary interest in the future. Finally, pay off your other debts, save for emergencies, and increase your retirement contributions as you go.

If you’re looking for a financial planning partner who can help you realize your retirement goals, we have financial planning offices in Redmond, Seattle, Mill Creek, the Tri-cities region, and Denver. Our firm focuses on helping retirees and those preparing for retirement achieve financial freedom by creating a plan that shows them how they can have the income they need and want until they turn 100.

If you’re ready to take the first step toward your retirement goals, our team is ready to assist you. We’ve helped hundreds of couples and individuals smoothly transition into retirement with confidence, and we’d like to do the same for you.

 

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