Do I Invest or Pay Down Debt

Oh, the classic dilemma.  Do I Invest or pay down debt with my money?  I want to make the best decision possible.  The way I look at it, there is a few main categories to consider.

Invest Versus Debt

Earnings

When we invest in the stock market, we can make 8% per year and a car loan could have a 3% interest rate.  We will assume we have $10,000 to use.  Do we pay off the car loan or invest it?  In the stock market, in year 1, we will assume we make $800.  Paying off the car would save us $300.  With $800 being larger than $300, this is why a lot of people like to invest as much as possible first.

Cash Flow

Now let’s look as the same example.  Assume we are paying $300 a month towards the car payment per month.  If we pay off the car loan, this will increase our cash flow by $300 per month, or $3,600 a year.  The stock market, even with the 8% yield, will give us $800 a year in free case flow.  So, paying off the car will give us a lot more free cash flow.  This is the reason why people like to pay off debt first.


Interest Rates

Sometimes it depends on the interest rate.  Say you had to take on a 20% interest rate loan or more for some life event.  That is a large interest rate.  At that point, it may make a lot more sense to pay off that loan first.  If you have a loan at only 2% interest rate, it can make a lot more sense to invest your money and pay the minimum amount.

Risk Tolerance

These 2 options have risk to them.  When we pay off the loan, the savings are locked in.  However, the money is gone and we cannot use it for other opportunities.  If we invest the money, we have an opportunity to make a lot more money than paying off the debt. However, investing has the risk of losing money.

Credit Score

If we have a low credit score, paying down the debt can make a lot more sense.  If you have too much credit card debt or too many other loans, this can make your credit score lower.  By paying down your credit cards or paying off some of your loans, this will improve your credit score.  By improving your credit score, it will help you save even more money.  The next time you get a loan, your interest rate will be better.  Sometimes, when you get a new service, a credit check is done.  By having a better credit score, you can get better terms, even though you are not paying an interest rate.

Do I Invest or Pay Down Debt Conclusion

When we were starting down our career path, we focused on paying down debt.  We had student loans and car payments taking up a lot of our flow.  As we improved in our career and paid off some of our debts, our free cash flow improved.

Even though we have not paid off all of our debts yet, and unfortunately have picked up new debts, like a mortgage and another car loan, we have a balance approach to paying extra towards our debts and investing.  How much we focus on paying down debts and investing does change over time. If one of our debts is almost paid off, we will focus on getting rid of it quickly.  If the stock market is having a correction, we start putting more money into our investment account to be able to buy more stocks.  Having flexibility helps as different opportunities arise.

Do I Invest or Pay Down Debt, that is the question?  Do you prefer to invest or pay down debt first?  Is there any other consideration we should think about? Please feel free to share your thoughts on investing or paying down debt in the comment section below.

 

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10 thoughts on “Do I Invest or Pay Down Debt

    1. IH,
      It is a personnel choice. Laying out the benefits of both helps me think about it. I do enjoy eliminating debts and the increase cash flow that follows. Thank you for the feedback.
      DM

  1. Hi DM
    As a retired financial planner I know that when I advised customers who asked this question, my answer was always to reduce debt first. I have seen many people who inherited or accumulated funds and felt it was better to invest rather than pay this money of their home loan. I used to always tell them the same story – “when you took out the loan did you say ‘ this is fabulous, I want to keep this loan going for as long as I can” or did you say “this is fabulous, I want to pay this off as quick as I can” Debt reduction is incredibly important for both financial and psychological well being. Don’t ever fall into the trap that most of the financial advice industry advocate, and that’s to invest excess money – why, because they don’t make commission unless you do! I enjoyed the post

    Regards, Adrian

    1. Adrian,
      Thank you for the feedback. Becoming financially independent does involve becoming debt free for me. I like to get rid of debts quickly. The only one that the will take me too much time is my mortgage.
      Thank you for commenting,
      DM

  2. I would agree that it is a personal choice as long as you pay down some of your debt all the time. Having debt without doing something about it is a loosing strategy, I would say. How much you pay down every so often is up to you. I for one would like to keep some of my cashflow for investing and use some for debt reduction. The ratio between the two is flexible. So I completely agree with your flexibility argument.
    Thanks for sharing your view.

    1. DIB,
      Thank you for commenting. Having flexibility, with a lot of thing, allows for better decisions to be made. As they say, when the facts change, I change my mind. So as my financial situation changes, I try to remain flexible to make the best decisions possible for me.
      Thank you for reading,
      DM

    1. I use a higher % interest for myself. But either way, I want to get rid of all of my debts. I try to always be saving and paying down debts at the same time. I hope the 4% rule is working for you.
      Thank you for sharing,
      DM

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