Should you invest or pay off debt?
Seriously, this may be the bane of our existence as millennials laden with student loans and first-hand observers of our boomer parents, grandparents, or great-aunties working well into their 70s in fear of suffering from a serious retirement income drought.
The constant choice we have to make? :: Invest for the future or pay off debt from the past?
Nobody wants to be in debt, nor do they want to be paying off debt for the next 20 years of their life.
But I don't think anyone wants to be old and broke either. (Especially when it's more difficult to make money when you start really showing signs of the aging process. Hey, that's evolution for ya.)
Make The RIGHT Choice
We're facing this fork in the road in making a smart, sound, financial decision. And it's filled with all this pressure and has us freaking out about the future.
It's like choosing between the black suede lace-up flats or the camel suede wedges.
You need shoes, you know you need to make a choice, you don't think you can afford to get both, but God forbid you make the wrong decision.
So you walk out, barefoot. No choice - No progress.
That may sound like a ridiculous comparison, but I think you get the point.
And then you hear the "smart" friend expressing their rationalization about why they do what they do with their debt and investments.
But is that the right decision for you? What is the right choice for you to make?
I hate having to say this but... it depends, per usual.
But there are some rules-of-thumb that you can follow when you're making this decision.
And if you implement and act on them in your financial life, you'll be much better off than not doing anything at all.
Whether you have a mortgage loan, a car loan, or a student loan, and you're facing the long-term decision of investing in retirement, then this post should be helpful.
Meet The Minimum
First rule of thumb, always meet the minimum. You're loans need to be paid, and you want to avoid defaulting on these as much as possible so do the responsible thing and meet the minimum monthly payments.
If you have a bajillion different loans and want to have only one or two monthly payments to make sure you're meeting all of your minimums, look into consolidating your student loans.
Meet The Match
The absolute best (and easiest) return you will ever get on your money is from the match your employer gives you for your contributions towards your retirement plan.
If you have a retirement plan at work, specifically an employer-sponsored 401(k) or SEP IRA, your work may provide a matching contribution as a benefit for you being a loyal worker.
Detailed in your benefits package (or you could just call your HR representative) is the terms around your employer's matching contributions.
Whether they are "100% up to 6% of your paycheck," or a more funky and confusing "100% up to 3% and then 50% of the next 3% and nothing after 6% of your paycheck," this is still a great return on your money. - Trust me.
Let me break it down.
If you make $2,000 (before taxes) every time you get paid, and you contribute money to your retirement plan up to the employer match (the full 6%), you will be putting $120 into your retirement with every paycheck.
If your employer follows the first scenario from above, they will give you a 100% return, instantly, on your $120 investment by also contributing $120. After a year, that's approx. $3,000 of free money each year from your workplace!
If your employer is more like the second scenario, they will still give you $60 off the bat (100% matching up to 3% of your salary) and then another $30 for the next 3% you contribute for a total of $90 extra buckaroos. That's still a 75% immediate return on your $120 investment. Not too shabby.
Like I said, this is the easiest way to get the best return from your money. If you're purely looking at the numbers, and can spare to set aside 6% of your salary while meeting your minimum payments, then this is the absolute next step for you!
Never put your "Oh, Shit Account" in the corner
There are two kinds of people in this world.
The humans that like to see A LOT of money in their bank account because it make them feel safe at night. (Like teddy-bear-in-bed safe.)
The humans that can't stand to see a significant sum of money in such a low-interest bearing account. Just think of all the gainz they're missing out on! (When I put a "z" on the end of any word that doesn't require a "z", the sentence should be read with a sarcastic tone.)
Here's the deal. Your emergency savings account is an absolute necessity for feeling like you can handle any disaster that comes your way. (The way I assume Olivia Pope would, obvs.)
But it's also essential for actually handling disasters without going into more debt.
So you're going to need to prioritize this next. You don't need to get up to 3 or 6 months of emergency savings before throwing extra money at investing or debt, but you do want to at least be doing both.
My tip is to get to $1,000 or one-month's worth of rent. Then split the excess cash between funding your "Oh Shit Account" and the next step.
Look At Interest
Alright, you are meeting your minimum payments, investing for retirement by scooping up that fantastic employer match, and you got the ball rolling on (or have fully-funded) that emergency savings account.
But you still have some extra dough that you want to use responsibly, according to the Surgeon General. (Who I always envisioned looked a lot like Colonel Mustard.)
This is where things get muddy, you will never know if your decision is going to be the right one, and it's always going to depend and things will definitely change throughout the years.
First, look at your interest rates on your debt.
Anything with a rate higher than 8% has GOT TO GO.
Credit cards and private loans are the bloodsuckers here.
Use the debt snowball or debt avalanche method with these guys and hit 'em hard.
Why? Because the average long-term rate of return (on a good day) is around 8%. And I'm talking over the course of many many years here. Hence the phrase "long-term rate of return."
You're better off paying down this debt and then focusing on investing. But good on you since you're already making those contributions that get a solid match right off the bat!
Debt with an interest rate at 4.5% or lower can take the slow-and-steady route.
If you're purely concerned about maximizing the power of your money, than take the slow road with this. I know it's difficult to do, and of course you can pay this off when you become a millionaire or receive a large windfall of cash in the future, but for now, ride out the storm by just making the required monthly payments.
Things like a mortgage and a majority of federal student loans will fall in this category.
Debt with an interest rate between 4.5% and 8% is up for debate.
You're going to have to make the decision on this one, but don't drive yourself crazy. The whole point of this is that you're moving forward.
Gauge how paying down debt makes you feel versus investing.
When your debt is all paid off in the future, determine if you will be disciplined enough to use all your debt repayment money towards investing.
There will be a day when suddenly you have $275 extra dollars a month to your name. - I promise.
No matter your choice, you can't really go wrong here.
Sure, you can analyze all the variables and assumptions and tax savings and interest savings and drive yourself crazy.
But at the end of the day, you have to do what makes you feel better about your money sitch.
My Final Thoughts
You can do all of this or you can do none of this. Everyone has their own opinions on how to handle their financial situation, but if you're overwhelmed by adulthood and just want to make the right fricken choices, then I got you babe.
In fact, you can work with me on it. (I'm a financial coach, after all.)
We will put together a game plan based on the general rules-of-thumb (and probably a lot of me working with your numbers in a spreadsheet because I'm a nerd like that), set your plan on autopilot, check-in with it periodically, and together we will finally stop freaking out about the future.
Oh, and finally buy both of the suede shoes. Because suede is so in right now.
Fancy a chat with me to see if we should work together? I only take on 3 clients a month so snag your spot pronto.