Should I start investing if I have outstanding debt?
Q: I’ve heard about the “magic of compound interest” and I’d love to start investing now. The only problem is that I have some consumer debt to pay off. Should I start investing if I have outstanding debt?
A: Investing works best when it’s left to grow for the long term. However, carrying outstanding debt may not be good for your financial health. Trying to determine whether you can start investing when you still have debt to pay off can be a difficult question to answer. Here are questions that can help you determine whether you should start investing before getting rid of your debt and various factors to consider when making this decision.
How high is your interest rate?
Your first consideration when making this decision is the interest rate on your debt. Credit card debt tends to hover at 20%, on average. The stock market, in contrast, has historically returned 10% for investors. When you run the numbers, investing money you could otherwise use toward paying down high-interest debt will generally not make sense. This is especially true when interest rates on credit cards are currently rising.
If the interest rate on your debt falls under the 10% mark, it may be worthwhile for you to start investing while still carrying debt. As always, that decision should also be countered with awareness of your current financial standing. Keep reading as we discuss those factors.
How much outstanding debt are you carrying?
The next factor to consider when making this decision is the amount of debt you are carrying. If your debt is impacting your budget and making it difficult for you to get through the month, you’ll likely want to pay it off before you begin investing. Carrying a large amount of credit card debt can negatively impact your credit score. A low credit score, in turn, can prevent you from qualifying for large loans and possibly even obstruct your employment opportunities.
What kind of debt are you carrying?
Not all debt is created equal. There are, in fact, some good kinds of debt, which will ultimately increase your net worth or earning power. These include mortgage loans, auto loans, home equity loans that are used for home improvement projects and student loans. On the flip side is bad debt, which will not boost your equity or earning power, such as credit card debt and most personal loans.
If you want to start investing, but you’re still paying off your mortgage or your auto loan, don’t let these hold you back! As good debt, these loans will not lower your credit score and should not have a negative impact on your general financial health either. Of course, you still must make full and on-time payments for this to remain true.
What is your retirement timeline?
It’s never a good time to carry outstanding debt, but it’s especially not recommended to bring debt into retirement. If you’re nearing the end of your working years and you’re still carrying debt, it’s probably best to work on paying it off before you begin investing.
However, if you’re still years away from retirement and you’re carrying outstanding debt, it’s important to remember that you can never make up for the gains of compound interest that accumulates over several decades. To that end, you may want to consider investing a small amount of money in your retirement by making modest contributions toward it each month.
How can I invest and pay down debt?
The good news is, you don’t necessarily need to wait until you’ve finished paying off all your debts before you begin investing. If you aren’t carrying an exorbitant amount of high-interest debt, here’s how you can start investing while paying down debt:
- Continue making monthly payments toward your debts. Neglecting your debts can have catastrophic consequences for your credit score and general financial health. Be sure to continue making minimum monthly payments, or more, toward each of your outstanding debts even after you’ve started investing.
- Build an emergency fund. Experts recommend having three to six months’ worth of living expenses stashed away in an emergency fund. Having this money set aside will enable you to stay afloat through almost any eventuality and help you avoid spiraling further into debt.
- Consider debt relief. If you’re drowning in debt and can’t seem to find a way out, consider taking steps toward lowering your debt. You can take out a debt consolidation loan or an unsecured loan used toward paying down debt, which will leave you with one low-interest monthly payment to make. Or, you can reach out to your creditors to negotiate for a reduced interest rate.
- Boost your income. If you’ll be channeling the funds you’ve previously used for paying down debt each month toward investing, consider boosting your income through a side hustle. Use this extra money for meeting your monthly debt payments.
Investing is best when compound interest can work its magic, but carrying outstanding debt can be devastating for your financial health. Use this guide to learn when and how you can start investing while still paying down debt.
