The question of whether to pay off your debts or invest towards retirement is a common one, and the answer is not always straightforward. There are a few factors to consider before making a decision:
Interest Rate
The interest rate on your debt is one of the most important factors. You should compare your interest rate to what you expect to earn on your investments, and put your money towards the higher percentage figure.
For many people it makes sense to follow the 6% rule. Meaning if your debt has an interest rate of 6% or greater, consider paying it down before investing. For example, the average credit card interest rate is nearly 20%. It is virtually impossible to find an investment that consistently returns 20% or more, thus you would be better off paying down your debt.
The only caveat here is your 401(k) match. I recommend contributing enough to get your full match before paying down debt. Your match is a 100% return and is almost impossible to beat.
Time Until Retirement
Managing finances can be challenging when dealing with high-interest rates, and it can be especially tricky on a fixed retirement income. It’s essential to pay off as much high-interest debt as possible before you stop working. Ideally, entering retirement with no debt should be a priority.
Emotional Cost
While some people make decisions purely off numbers, most people take their emotions into account. For some, having zero debt provides peace of mind that outweighs the opportunity cost of investing in the stock market.
Additionally, ownership can often provide individuals with more freedom since they have complete control over their possessions and can make decisions without the need to contact lenders. Although I am not a homeowner yet, I can relate to this through my experience of owning cars. Holding the title provides me with a sense of flexibility that I value.
Tax Considerations
Depending on your income, saving towards retirement can come with tax benefits. Traditional 401(k) plans grow tax deferred and Roth accounts grow tax free.
On the other hand, some forms of debts come with tax benefits. For example, interest on mortgages, student loans, and business loans are often deductible. Check with your tax professional to see if you qualify.
Bottom Line
It is important to consider these factors when deciding whether to pay off debt or invest. It doesn’t necessarily have to be an all-or-nothing choice. Depending on your unique circumstances, it may be possible to strike a balance between the two options. Ultimately, it’s up to you to weigh the potential benefits and risks of each approach and make an informed decision that aligns with your financial goals.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
Disclaimers and Sources:
Average credit card debt from CNBC.
Mortgage interest deduction from the IRS.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. We suggest speaking with your financial professional about your situation prior to investing.
