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Writer's pictureDan Cook, CFP®

Should I Invest or Pay Off My Debt?


 

Imagine this: You’ve just received a $10,000 windfall. Do you use it to chip away at your mortgage or student loans, or do you invest it in hopes of a bigger return down the road? It’s a dilemma many face, and the stakes are high. In fact, according to a recent survey, nearly 70% of Americans grapple with deciding whether to pay off debt or invest, often unsure which path will lead them to financial freedom. Take the story of Sarah, who was torn between these two options. With $50,000 in student loans at a 6.5% interest rate and the temptation of a booming stock market offering potential 8% annual returns, she knew every decision she made could change her financial future. As we dive into the pros and cons of each strategy, you'll discover how factors like interest rates, investment returns, and your personal financial goals can either propel you toward wealth or keep you anchored in debt. The choice isn't just about numbers—it's about crafting the financial journey that best suits your life.

Couple Paying off Debt

Choosing between investing and paying off debt isn't a one-size-fits-all decision; it hinges on your individual circumstances and financial goals. Several factors must be considered to determine the right balance between these two strategies.


Focusing on debt repayment can be a smart move if you’re grappling with substantial debt, especially with high interest rates. Although you don’t earn a return on this money, you save significantly on interest. For instance, consider a $300,000 mortgage at a 7% interest rate over 30 years. If you stick to the minimum payments, you’ll pay over $418,000 in interest, making the total repayment around $718,500. However, paying a little extra each month can save a substantial amount: an additional $100 per month reduces your total interest by $69,338, $500 saves $200,235, and $1,000 saves about $266,603.


Conversely, investing presents a different set of benefits and risks. While paying off debt provides guaranteed savings by reducing your interest burden, investing offers the potential for future growth, though with less certainty. For example, if you invest an extra $100 a month over 30 years in an account with an 8% annual return, your total contribution of $36,000 could grow to approximately $135,939, including $99,939 in returns. Additionally, investments generally allow for greater liquidity, meaning you can access your money in case of emergencies or other needs.


Comparing debt repayment and investing is not a direct apples-to-apples scenario. Factors such as the time frame of debt repayment versus investment, interest rates, and your personal cash flow all come into play. Investing may offer higher potential returns and greater flexibility, while debt repayment provides peace of mind and clear, measurable savings.


When making this decision, you need to consider other factors such as retirement account matches, tax implications, and your personal financial goals. For instance, employer matches on retirement contributions are essentially free and should be maximized. Depending on whether you itemize, taxes can affect investment returns and mortgage interest deductions. Retirement accounts such as Roth IRAs might offer tax-free growth but come with access restrictions until retirement age.


Ultimately, the decision depends on your individual financial situation and goals. Both strategies have merits, and the best choice depends on what aligns with your long-term objectives and current financial status. Assess the big picture, evaluate all options, and choose the path that best supports your journey toward a secure financial future.



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