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Should You Pay Off Debt or Invest?

If you have some money and you don’t know what to do with it then there are 2 sensible options you could consider. The first one is to pay off some of your debt and the other one is to invest the cash. So which one should you choose?

Be Sure on How Much You Have

The first step to carry out is that of being sure that you really have money to invest or to pay off debt in the first place. If you are extremely keen to get your finances in order then it is possible that you might overestimate your ability to do either of these things. If you haven’t already done so then this is the perfect moment to set up a budgeting spreadsheet and see exactly where you stand. If you start off working to an incorrect assumption then you don’t have much chance of getting the right answer at the end of it all.

Think About Your Emergency Fund

If you have been through some tough financial times then you will probably be desperate to start to invest or pay off some of your debts. However, a better idea might be to consider the need for an emergency fund first of all. If you don’t have this in place then what would happen if you had some sort of emergency after investing your cash? To get onto a solid financial footing for the future you should really look to start by setting up an emergency fund that you can fall back on. An emergency fund might not be the most glamorous thing in the world but it could be exactly what you need to dig you out of a hole at some point.

Work Out the Saving Made by Repaying Debt

Ok, so this is the bit where you need to sit down with a calculator and work out what would be best for you in a financial sense. To do this you will want to work out how much money you would save by repaying debt early. This means seeing how much less interest you would need to pay in the long run by doing this. Be sure to check whether your loan has some sort of clause on it that would lead to a charge being made for early repayment.

Calculate the Investment Possibilities

Now that you know how much you could save by paying off some debt, the next step is to see how much you could earn by investing the money instead. With some types of investments this will be a fixed figure that you can calculate easily. However, in other cases it could be far from clear how much you could earn from your investment. When this is the case you won’t want to be overly optimistic and expect to get in the absolute maximum return possible. It is far better to err on the side of caution and calculate a lower rate of return. Finally be sure to take all trading fees into account when using and choosing an online brokerage account.

Think About the Tax Implications

When you are working out whether to invest money or clear off some debt you need to also understand the tax implications of doing this. For instance, the profits from your investment could be subject to tax. On the other hand, if you are thinking of paying off part of your mortgage then you need to take into account that these payments are not usually tax deductible. The tax issues add an extra degree of complexity to your calculations but it is definitely something to take into account.

What have you chosen to do when in this situation in the past? What would you like to do in the future?

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8 Responses to Should You Pay Off Debt or Invest?

  1. dojo says:

    I’d pay off the debt and then invest. For me debt was a HUGE deal and I hated it, even if it lasted only for 4 years.
    dojo recently posted…Small Business Ideas: Event (Party) PlannerMy Profile

  2. Alexis says:

    I think paying off debt is incredibly important. What is also important is developing an emergency fund, like you mentioned. It’s always important to have backup money.

  3. Other than investing in my employer sponsored (and matched) 401K, I’m choosing to pay off debt first, primarily because my interest rates are much higher than what I’d typically earn in an average year on the market. This is a great way to analyze your data if you’re unsure which way to go though. Thanks for sharing!
    Kayla @ Red Debted Stepchild recently posted…August Blog Income ReportMy Profile

  4. Its never a clear cut path for some folks on whether to save or invest. IT all depends on your risk meter and your ability to calculate the math correctly. If you will save 500 dollars a year by paying off a big chunk of debt or on the other hand you will earn 300 dollars a year in dividends. Well the smart thing to do in that case is to pay off the debt, as your getting the biggest bang for your dollars.
    EL @ Moneywatch101 recently posted…Blogging for 3 YearsMy Profile

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