A great deal of financial success depends not on how much money you make, but what you do with that money. It’s all about making the right choices and having your priorities in order. You might only have enough cash to pay off your debts, or to start saving or investing – but not enough for both. That said, when choosing whether to pay down an expensive debt (such as credit card bills) that is charging interest or whether to make an investment – paying off the debt first usually seems like the most obvious choice.
However, the answer might not be that simple. There are some situations in which investment might come before paying down debts, depending on the circumstances. Here are some questions to ask yourself when determining whether you should pay down your debts or invest:
How Much Interest Are You Paying on Your Debt?
Calculate what the rate of interest is that you are paying on your debt and compare it against the return you expect to earn on your investments (after taxes). If you have high interest debt, such as a credit card, the amount of interest you will be paying will likely be quite high. However, there are also different types of low interest debt which include student loans and mortgages.
One you have calculated both your debt interest and the possible return on your investments, compare the two. It’s simple – if you can earn a higher return on your investments than the expense of the interest payments on your debt – you should consider investing. If not, then maybe now is the time to pay off your debt.
Of course, this is not to say that you should neglect your debt completely. In this situation, it is still important to set aside some income to keep the debt current and to pay off the minimum, so that getting behind on your debt doesn’t damage your credit rating or cause you to incur additional fees.
Do You Have an Emergency Fund?
Although the previous scenario suggests that investing before paying down debt can sometimes be the best option, this assumes that you already have an emergency fund in place. An emergency fund is a large chunk of savings that you will be able to rely on to support you if something unexpected happens – such as losing your job or getting ill. This means that if things go wrong, you will not get yourself stuck in debt.
It is important to have this emergency fund in place before you start making investments. The point of an emergency fund is the fact that it is readily accessible, so if all of your money is tied up in investments it will be inaccessible to you when you really need it.
You might want to take a divided approach to your finances. With the extra money you have every month, you could put some toward paying down debts, some toward saving up an emergency fund and invest another portion. This makes sure that all of your financial bases are covered – and you can always adjust the ratios in the future depending on your circumstances.
Samantha Smith is a experienced blogger who often writes articles about investments. Her interests are the stock market, investing and the media. She has wrote articles for alot of companies and magazines such as EK Investment Ethical.