A balanced approach to wealth management serves
both today’s needs and tomorrow’s goals. For some, that may mean paying off some debt today while
simultaneously investing for the future.
Of course, your own needs and circumstances
will be unique. But hopefully, this video can help you evaluate alternatives and find an
approach that fits your situation and goals. If you have some extra cash flow each month, you
might be wondering what the best thing to do with it is: should you pay off debt, or should you
instead invest? The answer can be complex, and it varies depending on your financial situation.
So, it’s crucial to consider where you are financially, the rates of return you could expect
with each option, and a variety of other factors.
So before you start putting money away toward
either option, it’s essential to make sure you have your financial basics covered. And
the best way of doing this is to create a budget if you don’t have one already so you
can see how your monthly income is spent. Since your finances are finite. You, therefore, have a limited amount of money to pay down
debt, invest and cover your expenses. This is why it’s important to learn what
comes in and goes out each month. If you stick to your budget, you’ll have
better control of your personal finances. This will allow you to dedicate as much
cash as possible towards each ‘category’, thus increasing your net worth whilst
building a solid financial plan.
Once you determine the amount you’re able to
set aside for paying off debt or investing, you’ll need to prioritise your options. Investing is a way to set money aside for the
future in an investment vehicle. Examples of this include bonds, stocks or mutual funds. The
great news is that, the value of these vehicles will grow with time. On the other hand, debt
represents money that you’ve spent already and that your lender is charging you interest on.
When this debt is left unpaid, it only grows with interest charges adding to your balance
and incurring interest charges on their own. In the case of investing, this is the rule
of thumb: if you can earn more interest on your money by investing it than your debts
are costing you, then investing makes sense. Another thing to consider is your risk
tolerance. If you are comfortable taking the gamble that your investments will depend on
the rise and fall of the markets, then investing is a better option as opposed to someone who’d
be restless wondering how the market will be. When it comes to paying down debt,
there are several good arguments for opting to pay down debt rather than
investing.
For one, your debt carries a relatively high-interest rate. This is
especially the case with credit card debt. Another reason to pay down debt is your credit
score, which is important if you’d like to borrow money for a mortgage or get a loan on a car.
If you have a low credit score you’re likely to pay higher interest rates (that is if you
can get a loan at all). Your credit score can also affect other areas of your life. Some
examples include the premiums you’ll pay for insurance, whether you’ll be able to rent
a place, or if an employer will hire you. Paying off debt – especially if you have lots of it – can be the right way
to go for that reason alone. Psychology is also a factor that comes into
play. If your debts are making you lose sleep, then you’d rather repay them even if you might
get a better return on your money by investing.
When you think about it, paying down debt or
investing doesn’t have to be an “either – or” decision. Why not do both? Investing and
paying off debt are essential financial goals. Your investments and your debt
are elements of your net worth. While your assets increase your net worth,
your debts are dragging it down. Since your focus should be increasing your net worth, you
should aim to increase your assets and minimise your debt at the same time. To do this, commit
as much of your cash flow to fulfilling these goals as possible, ideally all of your free cash
flow after you factor in your necessary expenses. If you have high-interest rate credit card
debt, focus on paying it off first.
If you are investing when you have credit card debt,
you are likely paying a higher rate on your debt than you are earning via your investments.
Unless you have a huge amount in investments, you end up losing money overall. Some debts
tend to be lower however, such as mortgages and student loans which you don’t need to be as
aggressive with those as with high-interest debts. How to start investing Investing your money is important to
building wealth. But you need to make certain you’re ready before you start
using your cash to buy investments. If you have a lot of credit card debt, you
may not be in a position to invest much.
When you have a limited amount of money, you
have to decide how best to use it to maximise the return on investment it provides. In most
cases, paying off credit card debt is going to provide a better return on investment than just
about anything else you could do with the money. The one exception to this is if your employer
provides a 401(k)-matching contribution when you invest in your workplace retirement plan.
If your employer matches contributions you make, that’s free money. The specific return
you get will depend on the percentage of contributions the company matches, but it’s
common for employers to match 50% or a 100% of contributions up to a certain percentage of your
salary.
So, investing enough to earn the full employer match could end up giving you a return on
investment of around fifty to a hundred percent. Investing in your retirement account is often a
good place to start. Experts recommend putting at least 15% of your annual income towards
your retirement. Whether you do this through a work-sponsored retirement plan or an individual
retirement account is up to you, but make sure you’re never leaving any money on the table, such
as from an untapped employer match to your 401(k). Retirement aside, the right investments
for you will depend on your risk tolerance. Stocks are generally riskier
than bonds. To lighten the risk, you can turn to mutual funds. They can
help provide diversification among stocks, bonds and other investments to reduce the
risk from each one individually. Your risk tolerance can be factored by income, age,
lifestyle and when you’ll need the money. Carrying debt can be stressful, and if
it negatively impacts your mental health, you may want to prioritise paying debt
down first. Debt can completely derail your financial goals. It eats through
your savings and can offset the gains you make through investing.
On the other
hand, you may have a better chance of a bigger reward with smart investments,
so you may decide that’s worth the risk. Keep in mind that investing doesn’t come
with guaranteed growth. Any average or likely rates of return you may see are
often based on long-term performance; you may experience higher highs,
and lower lows in the short term. If you choose to invest, by no means should
you stop paying off your debt entirely. You should aim to at least make your minimum
monthly payments before you put any spare cash toward investments. You really don’t
want to miss your minimum payments. Think of your minimum debt payments as fixed
expenses. After regular living expenses, minimum debt payments should be the
next priority.
Failing to do so, could lower your credit card score making
it harder to qualify for future loans. The younger you are when you start investing,
the more time you have for your investments to grow. However, there’s no guarantee
that you’ll make money when you invest, as the market can be volatile. If
you’re relying on an increased balance within a short amount of time, you might be
disappointed.
Whichever decision you make, your decision is never set in stone. You can
always switch up your budget if your financial situation changes or if you’re unsatisfied
with how you’re currently allocating your money. The important thing is that you’re
taking charge of your financial future. Make sure you have an emergency fund
in place before you use extra money to contribute to these goals. An emergency fund
should contain between three to six months’ worth of expenses that can protect
you in case unexpected costs come up. Without a financial safety net, you’re one
unexpected medical bill, car accident or surprise expense away from even more debt. Some people,
particularly those worried about income loss, prefer building a large cushion of cash for
emergencies first over paying down extra debt. By using automatic deposits, you can create
an investment plan and stick to it over time, treating your investments as part of your
fixed budget. Your safety net will give you some financial breathing room, and before you know
it, you’ll be making progress toward retirement, a down payment on a house, college for
your kids or whatever goal you had in mind.
As you approach saving, investing and paying
off debt, keep in mind that it doesn’t have to be all or nothing. You don’t just have to focus
on one thing at a time. If you do, it could end up taking longer to start working on each of
your goals, which could delay your success. The best path to long term financial
sustainability is paying off debt and investing at the same time. This approach will
help you improve your financial discipline, and will ensure that all of your hard-earned cash takes you one step closer to achieving
your financial goals one cent at a time. Try and find a balance between everything.
While
it can take a little longer to achieve each goal this way, it can give you a more well-rounded
financial foundation and pay off in the long run. When making decisions about
debt reduction and investing, keep in mind that the need to
eventually pay off principal is certain, but investment returns are not.
Investment performance will vary over time, and it’s possible to experience losses as well
as gains. At the same time, it’s well known that investors who start earlier can benefit
from compounding and time in the market. But there aren’t any magic numbers. That’s
why it’s important to work with your financial advisor to create an investment strategy that
fits your financial expectation for the future. Having some extra cash is an enviable situation
to be in. When making decisions about debt and investing, be a long-term thinker: Think
about the position you want to be in the next ten or so years.
Then evaluate what
actions today will be most effective in helping you achieve your long-term
financial goals. Whether to invest or pay down your debts is a decision only you
can make. Whichever you choose is better than merely spending it. You’ll be in a better
financial situation than you were in before. If you’re interested in getting my savings
and budgeting guide or retirement guide, click on the link in the descriptions. Well, thank you all so much for watching, if you
found this video helpful, be sure to give it a thumbs up and subscribe to our channel for
more tips on how to improve your finances. Until next time, take care!.