In this world of relatively easy credit, it isn't uncommon for successful investors to accumulate high balances on their revolving types of debt, such as credit cards, while also having the means to pay it off. A typical scenario might be similar to an investor having $15,000 in credit card debt while also having more than $15,000 in her bank account. But what should she do? Pay off that debt or invest the money?
What if she had the potential to earn greater return from investments than she was paying in interest? Many face this dilemma, and it's easy to see why; after all, it's important to invest for the future, but if you're still paying interest on debts, does it really make sense? Is there a rule about which should take place first, investing or paying down debt?
There's no simple answer to this question. Rather, consider which option will help you reach your financial goals more quickly. These tips from investment professionals may help you decide on a financial strategy.
Compound Interest vs. Credit Score: Financial Planning Tools
Investing means reaping the benefits of compounding interest over time. But that means not paying off debt, and that means paying the interest and ensuring that you're not harming your credit score. But if you pay off debt, you won't gain that compounded interest. So what's the solution?
To decide which course of action makes the most financial sense, arrange your debts with the highest interest rates first in order to determine which ones are most costly. Debts with a high rate -- anything over 10 percent -- should be paid off first.
When you're totaling up your debt, pay more attention to interest rates than how much you owe. High interest can add thousands to your payments over time; looking at exactly how much interest is adding to your debt may spur you to take action. You can really drive the point home by comparing how much interest you pay each month just to stay afloat on another bill or expense you pay each month, like a car payment, a food bill, or other household costs. Until you make the connection between money in your pocket and those vague numbers on your credit card statement, it can be all too easy to ignore the debt.
Financial Strategies: Retirement Planning Tools
Make it even more "real" by using an online calculator to figure out how long it'll take you to pay off your debt. You can enter different payment amounts and time frames, as well as compare debt interest payments to potential investment interest gains.
Student loan debt is a special category. If you've got student loans hanging over your head and you're nearing retirement age, make every effort to pay it off as soon as possible. However, if you're in your 20s, go ahead and focus on investing while still making payments.
Finally, even if you're paying down debt, take advantage of retirement tools such as employer-sponsored 401k accounts. Invest as much as you can in order to take full advantage of employer match contributions, even if that means it'll take a bit longer to pay off debt.
As a bonus, paying down debt will help youdevelop good financial strategies for the future. Once you've paid off your debts, keep putting money aside each month for retirement. You'll already be in the habit.