Should you invest while still in debt?
Yes and no, but for most people – no.
Investing while still in debt is usually not a wise strategy because it is likely that you are paying more in interest on debt than you would earn in interest on investments. That is not always the case, but it is the most common case.
So is investing while you are in debt ever a good idea?
Investing is NOT a good idea if…
1. You still have high interest debt
I still have over $10,000 in high interest debt at 9.32%. While I still have this debt, unless I can earn a guaranteed interest rate of 10% or higher on my investments… I’m actually losing money.
Rather than invest while I still have this looming high interest debt, it is in my best interest to pay off this debt… then begin investing.
2. You do not already have well established personal cash savings
Currently I have just over $3,000 in my interest bearing savings account. Before I begin channeling money into investment accounts, I need to grow this significantly larger. How large? That depends on your situation. Personal finance is personal so save whatever amount works for you and your situation. Before investing, I intend to build my Emergency Fund to $20,000 (which is equal to 6 – 9 months of current family expenses.)
Investing IS a good idea if…
1. Your only debt is low interest
If the only debt you have left carry low interest rates, then investing is a good idea.
What debt is low interest debt? Any debt that carries a interest rate that is considered low. I suppose this can be all relative, but typically mortgages and student loans fall into this category – as well as some business and personal loans. For my wife and I, our low interest debt includes our 1st mortgage (5.625%) and our student loans (mine at 6% and hers at 4%.) Once these debts are the only we have remaining, and our Emergency Fund is funded with our 6 – 9 month buffer, most of our extra money will then go toward investments.
2. If your employer matches your 401k contributions
If you have the benefit of an employer matched 401k, then it is almost always a good idea to contribute, even if you are still in debt. Reason being, it is free money. Typically employer matching programs pay 50 – 100% of what you contribute up to a certain percentage of your salary. For example: Joe earns a $3,000 monthly salary, his employer matches 100% of his 401k contributions up to 5% of that salary. So if Joe contributes $150 every month, his employer will also contribute $150 every month. That’s smart Joe.
You can see that not contributing will effectively cost Joe $150 of free money each month. That’s not smart Joe.
There are a few exceptions to this rule.
- Your employer contributions are vested over several years and you do not plan to be with your employer long enough to realize the benefit. For example: you become vested 20% each year starting with year 2. So the 1st year you are 0% vested, 2nd year=20%, 3rd year=40%, 4th year=60%, 5th year=80%, and you will not be 100% vested until your 6th year with the company. Clearly this is a problem if you only plan on being with the company for 1 year. This is the plan that my employer currently uses. I have been employed with them for just over 2 years, so I am now 20% vested.
- Once your bills and all the other expenses in your budget are met, you simply have no money left to invest. If this is the case, then you are living beyond your means and simply need to reduce your living expenses and make room for your investments. If the only debt you have left is low interest mortgage/student loan debt, there is no reason your expenses should equal your income.
Remember compound interest
The law of compound interest simply states that sooner you begin investing, the more you stand to earn. Does that law negate the previous points in this article regarding when not to invest? Absolutely not. Why? Because this law can work for you or against you. If you carry high interest debt, then the law is working against you and you need to pay that debt off as soon as possible. If you have no high interest debt then you should begin investing as soon as possible thus harnessing the positive power of compound interest for yourself.
Where do you stand? Should YOU invest?
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