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Pay Off Debt Or Invest? - How You Can Do Both

I’m sure you’ve heard of FOMO or Fear Of Missing Out, and I’m even more certain that you’ve felt FOMO yourself. It’s normal! And it’s especially common when it comes to investing. A lot of people want to rush into investing, whether in real estate or stocks, but they feel like they can’t do it while they’re paying off their debts.


Today I’m going to discuss which one should take priority - paying off debt or investing your money. I’ll even tell you how you can do both.

Why People Choose Investing Over Debt Repayment


One of the biggest reasons for choosing to invest when you are in debt is the belief that you can use the returns on your investments to cover your debt payments.

The fatal flaw here is that returns are never guaranteed . . . but the debt is. And you have to pay that debt no matter what (unless you ultimately file for bankruptcy . . . which is a whole different discussion). On the other hand, paying off debt is a guaranteed investment because you ultimately won’t have to pay any more interest the debt incurs once you pay off that debt.

The second flaw in aimlessly focusing on investing (at the expense of paying off your debt) is the fact that investing is a long-term process. In some cases, you won’t see returns for years when you invest, but you’ll see returns (in the form of no interest) immediately when you pay off your debt.

But, there’s a catch - because there are different types of debt. And the type of debt you have determines whether you should invest or whether you should first focus on paying off all your debt. So, the question becomes: What type of debt do you have? Do you have bad debt or do you have “worst” debt?

Bad Debt vs. Worst Debt

In my mind, all debt is bad debt! But banks have come up with the idea that something like a low-interest mortgage is “good” debt because you have thirty years to repay it. And, of course, it’s for something good - a house! But over those thirty years, you’re paying TWICE the price of the house because of accrued interest. Does that sound good to you?

That’s a bit of a rhetorical question. But, my point is: Even when you’re using debt to buy the “American dream,” when you’re paying huge amounts of interest on that debt, it’s not something I would necessarily refer to as good.


So instead of “Good vs Bad” debt, I like to categorize it as “Bad Vs Worst” debt. And these two categorizations are important because, as I mentioned, they can help you decide whether it’s better for you to invest or whether it’s better for you to first pay off all of your debt. It all comes down to the type of debt that you hold.


Let’s start with types of “Worst” Debt

Debts that you owe to family or friends - definitely worst debt! Though there’s usually no attached interest here, the cost is more about the strain it can put on your close relationships, which to me is worse than traditional debt.

Payday loan debts and credit card debt: This type of debt typically has very high interest rates - making it a worse type of debt to hold compared to a low interest home mortgage (for example). Tax debt: Tax debts are “worst” because the government can often skim the money you own from your paychecks. If you owe taxes on your home, you could also potentially lose your home. So, it’s always best to categorize tax debt in the “worst” debt category.

Types of “ Bad” Debt (often referred to as “Good” debt)

Mortgages and student loans: Interest rates are lower and payments are spread over a longer period with these types of debt. BUT, also keep in mind, these types of debt are also very easy to overextend. Maybe you buy too much home? Maybe you take out student loans that you don’t necessarily need? In these instances, you could easily find yourself switching what would typically be referred to as bad/good debt into the “worst” debt category - simply by borrowing money on something that you don’t need.

But, let’s assume you have some form of debt - either “bad” or “worst.” How do you determine what to tackle first - paying off debt or investing?

I’ve got two different approaches for you:


The First Approach For Paying Off Debt (While Still Investing):

1. Build An Emergency Fund

This approach assumes you have both bad and worse debt. Before tackling debt you should set up an emergency fund that covers at least one month of your expenses.

2. Make Some Lifestyle Changes

Develop a budget and use that budget to begin cutting out your discretionary expenses. Finding ways to increase your income is also a great idea, either by working extra hours where possible or finding a side hustle. Increased income and reduced expenses means you can be better equipped to cut into your debt.

3. Invest In Your 401k

This is where investing comes in. Though most of your extra income should be used to pay off your debt, it’s also a great idea to keep putting money towards your 401k. This is especially true if your employer is matching your contributions.

Depending on the type of debt you have, you’ll want to make the maximum contributions to your 401k before you start putting extra towards your debt with the remainder. Because if your employer is matching even 50% of your contributions that means you're making a 50% return, which is higher than the interest on most any credit card.

The exception would be payday loans, where interest rates can soar high as 300%! This is the kind of debt you want to repay as quickly as possible, even if it’s at the expense of contributing to your 401k.

With this approach, you have the option to both invest and pay off extra on those more aggressive debts. You’re also making positive lifestyle changes at the same time! By developing better money-making and saving habits, you’ll have more money to invest once you’ve finished paying off debts. The faster you pay them off, the more you’ll save by not paying interest, and the larger amounts of money you’ll have to invest.


The Second Approach

Once you’ve paid off the worst debt it’s time to pay off the bad debt. Now when it comes to paying off debt and investing, you need to think about your timeframe. For example, a lot of people forget to consider how much time they have left on their mortgage.

This is important because of your mortgage’s amortization schedule. When repaying a mortgage, you are generally paying the bulk of the interest up front, and the majority of the principle toward the end. So if you’re paying your mortgage after 15-20 years, you’re at a point where you’ve already paid heavily in interest and you’re mostly just paying the principal. You don’t have to ramp up repayments because, at this point, you’re not accruing significant amounts in interest.

Now let’s say you’re at the beginning of your debt payment on your mortgage. If so, investing is typically still a great option. That’s because the average return on an index fund in the stock market has been about ten percent over the past 100 years. This is higher than the typical interest payments on a mortgage. So, if we rely on the historical returns of the market, you may be more likely to have a bigger return by investing in the market (in a total stock market index fund, for example) than you would have by saving in interest if you were to pay off your entire home mortgage.

Notice my broad generalization ‘ “you may be more likely.” I do this for a reason . . . because what you need to realize most of all is that the best decisions regarding debt payoff versus investing often depend on your financial situation, your unique debt situation, and even your individual mentality. There is even psychology behind it. It’s referred to the psychology of spending.

Let me explain that one: Psychology has a lot to do with how you should spend your money. You may find that you’re not as inspired by investing as you are inspired by paying off your debts, including your mortgage. In these kinds of situations, numbers don’t matter so much as what is going to make you feel the most fulfilled and the most accomplished. And reaching financial independence is really a journey of fulfillment. So, if you feel inspired and motivated and fulfilled by paying of debt before you invest, even if the numbers suggest that you would be better off by investing your money, why not focus on what you find more fulfilling? Either way, paying off debt is a huge accomplishment . . . and so is investing.


At the end of the day, everyone feels differently about this topic. My advice to you: Look at the type of debt you have, look at where you are in terms of paying it off, and look at how you personally want to invest your hard-earned money. Do you have a strong emotional attachment to doing one over the other?

Explore your options, run the numbers, and understand your emotional response to debt versus investing. All of these things should hopefully make your decision a little easier.


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We’re former federal government employees that focused on saving, making, and investing money so that we could grow enough wealth in our investments to never have to work again.

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