Should you pay off debt or invest your money? It depends a lot on your unique financial situation, goals, and risk tolerance.
Getting rid of debts like your credit cards and loans can feel really good. You’ll have more cash flow flexibility and one less thing hanging over your head each month. Being debt free gives you a certain peace of mind that investing can’t match.
But on the flip side, if you invest your extra cash instead of throwing it at debt, you could potentially see bigger returns down the line. The stock market and real estate have historically produced larger gains than the interest you’re paying on most loans. And if those debts have low-interest rates, you’re probably better off investing and just making minimum payments.
Ultimately there’s no black-and-white answer—it’s about finding the ideal balance between reducing debt and maximizing your potential earnings that works for your specific financial life, which we’ll dive into today to help you make the right decision. So, let’s get started!
Peace of mind from paying off debt
There’s no denying that getting out of debt can feel absolutely liberating. Once those bills are paid in full, you’ll have one less thing weighing on your mind each month; no more facing minimum payments that eat into your income and wondering if you’ll have enough to cover everything. You’ll have more flexibility with your cash flow and way less stress.
Being debt free gives you back a sense of control and freedom over your finances that few things can match. So if peace of mind and relief from financial stress is a high priority for you, focusing on wiping out debts could provide huge benefits.
The security of having no loans hanging over your head might even allow you to advance your career or invest in yourself through education in a way that wasn’t possible before.
Guaranteed returns from debt payoff
Now compare settling a mortgage to investing your money, where you’re taking on risk in hopes of making a return. There are no guarantees in most forms of investing—the stock market could go down, an investment property could have long vacancies, or anything else could happen.
But when you pay off debt, you’ve locked in an immediate, guaranteed return equal to the interest rate on that loan. That’s a pretty attractive benefit and not something to ignore lightly.
Ensuring you’re maximizing your guaranteed returns from debt payments should definitely be a high priority before you consider riskier investments with possible but not certain higher returns.
The bottom line is you need to focus your debt payoff energy on any loans with interest rates over 8%-10%, especially credit cards. Get those balances to $0 swiftly, and then you’ll be in a much better position to consider carefully whether investing makes more sense versus wiping out lower-interest debts.
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Freeing up cash flow for future investing
So paying off your debts gives you guaranteed immediate returns and peace of mind, no doubt about it. However, doesn’t that also mean you no longer have that monthly payment taking a chunk out of your income once your loans are fully paid?
You bet it does.
And what does that extra cash flow each month give you the opportunity to do? You guessed it—invest that money for potentially higher returns than what you were paying in interest on those debts.
So in a way, totally wiping out your loans shouldn’t necessarily be seen as an “either/or” choice compared to investing. It can actually pave the way for more effective investing going forward.
Think about it; once that credit card balance hits $0, you no longer have to make that $500 a month minimum payment. Now you’ve got an extra $500 every 30 days that you’re free to put into investments that could earn you way more than the 17% interest you were paying on that card.
So while paying off debt vs investing often feels like you have to choose one or the other, the reality is that debt payoff can in itself be a kind of investment – in your future ability to generate even greater returns by freeing up cash flow for strategic investing long-term.
In short, don’t forget to think about the potential upside of the increased investing opportunities that come from having no more loans hanging over your head. Paying off debt fully could just be the first step toward maximizing your wealth building for the future.
Higher potential returns from investing
We’ve talked about the benefits of paying off debt, like guaranteed returns and more flexibility. But let’s be real—the main reason most people invest is for the potential to earn way more than the interest on their loans.
Over the long run, assets like stocks, real estate, and small business investments have historically shown much higher average returns compared to the rates on most types of consumer debt. We’re talking about potentially earning double or triple what you’d save in interest costs by paying off a loan.
Of course, investing comes with risks; there are no guarantees. But if you have a long time horizon of 10+ years, can stomach some short-term volatility, and make smart investment choices, there’s a good chance your returns will surpass what you’d save in debt payments.
And if the interest rates on your loans are under 5%, you’re likely better off investing instead and just paying the minimum on those debts. The potential returns from assets usually outweigh the costs of low-interest-rate loans.
So even though guaranteed returns from debt payoff sound nice, don’t discount the opportunity for significantly higher earnings potential that comes from parking your money in the right investments for the long haul. If you do it right, you could generate wealth that completely eclipses what you’d save by eliminating debt.
The tradeoff is more risk, but with proper risk management, the potential rewards of investing usually justify it.
There’s another option that takes advantage of having low-interest rate loans: using that cheap debt to potentially supercharge your returns.
This strategy is called “leveraging debt.” The idea is simple; instead of paying off a loan with a really low-interest rate, like 3% or less, you keep making the minimum payments but invest any extra cash you have.
By investing that money at a higher expected return than the interest rate on the debt—say 8% instead of 3%—you can potentially come out way ahead versus just paying off the loan.
So when interest rates on your debts are meager, using that cheap capital to fuel investments that earn a higher return can be a smart strategy to supercharge your wealth growth.
Of course, this only works if you can actually earn a return higher than your loan’s interest rate. Otherwise, you’re just losing money. But for disciplined investors who do their research, leveraging low-interest debt can be a lucrative tactic for boosting investment returns.
However, when it comes to high-interest loans like credit cards, the smartest move is usually wiping those puppies out as fast as humanly possible.
We’re talking 10%, 15%, or even 25% interest rates or higher on some cards. The costs of carrying that kind of debt are simply too exorbitant to justify investing instead of paying it off.
At those types of interest rates, you’d basically have to earn returns well above 30% or 40% just to break even versus paying off the loan. And that level of return is unlikely for the average investor, especially if you factor in fees and taxes.
Plus, high-interest credit cards tend to have fixed interest rates, the terms they come with aren’t usually in your favor, and there are often hidden fees.
So while investing may be a wiser option compared to paying off loans with interest rates under 5% or so, once rates climb above that level into the double digits, the picture completely changes.