There is a psychological battle that many of us go through when it comes to our finances. If you have debt, you might wonder whether it is best to pay it off or use the money and begin building a nest egg for retirement.
Every person’s situation is different, and the psychological role that debt can have on someone is unique to every situation. At times you might feel trapped and bogged down by your student loan debt, car payment or even a mortgage. The debt that is supposedly “good” seems to constantly weight on your mind. For those of us that face this predicament, it is important to find the right balance when determining what debt to pay off, how much to pay off and how much to save. I will provide some insight to help you decide the right balance for you.
Credit card debt/ high interest debt: You should always focus on paying off ANY high interest debt you may have. This may include interest that is accruing from unpaid credit cards or any other loan. Credit cards can carry interest rates of 20 to upwards of 30%. You will be hard pressed to find investment returns better than the interest you will be paying on high interest debt.
Do not feel rushed to pay off student loan debt: We are told constantly about the all-time highs of student loan debt and how the younger generation cannot buy houses or cars nor do much of anything until they get student debt paid off. This is true to an extent, but think about this… most student loan debt carries an interest rate of 6.8% or a little less. Now, compare that with returns of the S&P 500 that has returned at least 11% four of the past 5 years. Moreover, when it comes to tax time, you are only able to deduct up to $2500 of student loan interest.
Time not timing is everything: Some people get in the mindset of “Well I must pay off all of my debt before I start investing”. As I stated previously, everyone has a different mentality when it comes to debt. Nevertheless, the longer you put off contributing to a Roth IRA or maxing out an employer-sponsored 401k, the less time your money has to grow with compound interest. Let us use a quick example, say you had $50,000 and you put it into an index fund that returns 8% a year, after 30 years that original amount would turn into $503,000. However, with just five more years, a total of 35, that same $50,000 would now be worth $739,000. Do not delay your retirement.
At the end of the day, tackling one’s debt and investing is all about having an actionable plan. Create a plan, with a budget and stick to it. It takes time to pay off debts similar to the many years required for your retirement portfolio to grow. Patience and diligence will allow you to reach your financial dreams and live the life you truly desire.
Budget Smart, Invest Wise