There is an old notion that paying down all of your debt is the best use of your money. The
ultimate goal for many with this concept is to be able to retire debt free. However, there may be
cases that investing additional sums of money could be more advantageous than paying down
debt. Like many topics in personal finance, it depends on your individual situation if this is the
best allocation of your capital. Here are several key items that are important to consider in
making this decision.
WHAT IS THE INTEREST RATE ON YOUR DEBT?
This is a simple spot to start as when you pay down your debt you are essentially getting a
return on investment close to the interest rate on the debt. As an example, if you have a credit
card that is at 15% interest, by paying down your credit card you are getting a 15% return on
your investment. That is a tough investment return to achieve over time. On the other hand, if
you had loans or a mortgage outstanding closer to 3%, that is a more achievable benchmark to
potentially look at investing more and carrying the debt burden.
PEACE OF MIND
It is important to know yourself and your comfort level with debt. There are always cases where
you could come to the financial conclusion that maintaining debt and investing more could be
in your best interest, however, if having that debt is something that keeps you up and worried
every night - it may not be worth it.
SOURCES OF INCOME
When you are thinking about long term planning and where you will be in retirement, it is
crucial to think through what all of your sources of income will be and then breakdown what
your fixed expenses will be as well as your discretionary expenses. The more reliant you are on your
investment portfolio to generate your income, the more you need to scrutinize debt. Having to
liquidate additional investments to cover debt in a down market can be very detrimental to
long term planning. On the other hand, if there are multiple sources of more fixed income in
retirement relative to your expenses - you may have more optionality.
EMPLOYER SPONSORED PLAN
One of the most commonly used investment accounts is your employer sponsored retirement
plan. It is important to remember in evaluating your investment vs. paying down debt that if
your employer has a match on your contributions that can equate to a very large return on
investment. For example, if your company were to match 50% of your contributions on 5% of
your salary-that would equate to a 50% return on that portion of your contribution.
TAXES
With all of these scenarios in mind it is important to always look at the after-tax impact of any of
these decisions. Some forms of debt may have tax-advantaged deductions and some may not.
The type of investment account you are investing in similarly will have different tax statuses.
Such as reducing current income through an IRA, or future tax-advantaged income in a Roth
IRA. With these nuances it can be helpful to contact your financial advisor and tax professional.
There may be many other considerations for your individual situation, but the key takeaway with
any aspect of finance is to get started now. Whether you are just starting to save or gearing up
for retirement, putting a plan in place and continuing to monitor it over time is crucial.