At least once in your life, your father or financial advisor might have told you this advice:
"Start saving and investing money from day 1 of your job. Never stop investing toward your retirement or old age, even if you have to pay debts off. Because if you stop, you will lose a huge sum in your future."
While they are older and wiser, this advice has a slight problem.
If you invest all your money toward your future or spend to clear your debt burden, when will you live for today?
So, what to do? Should you pay the debt that has been accumulating? Or invest it and let the money grow over time?
Isn't this the dilemma every millennial suffers from today? Is there any definite answer to this?
Brace yourself: it all depends on YOU. The problem with personal finance is exactly that – it's very personal.
Since both are extremely crucial for your financial health, you must weigh both options before making any decision. Let’s delve right into it.
When Should You Prioritize Paying Off Debt?
There are times when putting a break on your investment wagon and paying back your debts first makes more sense. In the long run, they are beneficial for your financial health. Let's look into when you should prioritize repaying your debts.
Your Feelings Matter
Debt is something that slowly chips you away. It leaves you sleepless night after night. If that wasn't enough, debt causes psychological ailments like anxiety and depression. So, before you even start to consider the logical and calculative arguments, you should pay your debts for your mental peace alone.
But do not hurry to pay off your debts. Do not take a loan to pay off another. If you are not cautious, you will fall prey to debt traps. Read our blog on the debt trap here.
It is especially true if the debt interest rate is high. There are three types of debt that carry extremely high interest.
- Credit cards
- Personal loans
- Payday loans
On the other hand, some fixed-rate loans are available in the market that commonly carry less interest.
- Housing loan
- Car loan
- Education loan
Let's take an instance. On average, in India, credit card providers charge anywhere between 14% to as high as 47% annual percentage rate (APR)! Yes, shocking, but true. Whereas annual interest on housing loans on an average is 6-12%.
Suppose you have two credit cards and a home loan:
Card 1 charges you 34% APR
Card 2 charges you 23% APR
A home loan charges you 6.5%
Naturally, you should prioritise card 1 over card 2 and the home loan. But make sure you use your credit cards wisely. Read our guide on how to use credit cards like a pro here.
Maintain A Good Credit Score
Credit score has an important role in ensuring your ability to take loans, EMI facilities, or credit cards in the future. The three-digit number indicates whether you can repay your debt and maintain your financial stability.
If you miss your due dates, you have to pay late fee charges, which plummets your credit score. So, if you want to buy your own home or a BMW with a home loan or car loan, pay off your debts.
You Are Nearing Your Retirement
Retirement is a particular phase of your life when you'd like to concentrate on fulfilling your unfulfilled wishes and relaxing. No one likes to pay debt dues from their pension.
So, if you have a mortgage pending or have taken a loan to marry off your children, and you have only a few years left in your service life, prioritise paying your debt quickly, unless you are expecting passive income apart from your pension. You can invest even after your retirement.
But if you don't have this kind of pressing issue and have been left with some extra cash, invest it wisely. Let us tell you in detail.
How To Pay Your Debts Off
If you have the extra money in your hand every month, Early debt payoff should be your priority. Most of us don't have that luxury unless we have a high-paying income. So, what do you do? Here are four innovative ways:
Opt For Balance Transfer Credit Card
This type of credit card is specially designed to pay off high-interest credit card debt. Some cards even have a complimentary 6-18 month 0% interest rate. You can simply transfer the balance of this specialised credit card to the card you own and simply pay debts.
Take Debt Consolidation Loan
This loan allows you to borrow enough money to pay off another moneylender. But they come at a much lower interest rate. Thus, you only have to worry about repaying one loan.
Request To Reduce Interest Rate
If you are in a much worse situation where you cannot even pay the monthly minimum due amount of your credit card or loans, you should consider talking to your money lender. Request them if they can either reduce your monthly minimum due or lower the interest rate.
Let A Negotiator Handle
If you are in such dire need that you cannot handle the loan or credit card debt you have landed yourself into, consider hiring a reputable debt relief company. They will talk to your lender and handle all the negotiations for you.
However, make sure you are not falling for a scam. There are many scammy debt relief agencies mushrooming in the market. So, ensure you have all the required information that proves you are working with a legitimate company.
You Should Take Investment Decision If
We understand the allure of reaping high returns from your investments. Especially if you are a beginner. After all, financial investment is an important financial decision that impacts your present and future both. So, it should be done for the right reasons. So, you should invest your money instead of paying off debt only if you fall under the below categories:
Your Return Is More Than Your Debt Interest
If you are confused about whether to pay off your debts early or invest that extra money you are able to save every month, compare the investment return with the debt premium. Only if you find out your investment return is much higher than the interest of your loan or credit card should you invest.
Let's take a small example. Suppose you have a car loan that is charging you 7% interest on your borrowed amount. Whereas, you find out about a large-cap mutual fund or Index fund which is offering you 10-12% compound interest. But before you make your decision based on the high return, you must understand how you can profit from compound interest.
In compound interest, you get to earn interest on interest. Sounds complicated? Let us simplify it for you:
Suppose, you have invested ₹1,000 at 10% interest rate.
After 1 year, you are earning ₹100. So, your total amount becomes ₹1,100
Thanks to compound interest, next year you will get 10% interest on ₹1,100.
Thus, in the 2nd year, your initially invested ₹1,000 will become ₹1,210.
Now, you know how compound interest can quickly build your wealth.
You Are Not Afraid Of Taking Risks
Only the stock market and mutual funds can give you a high return. But it's not that simple.
Making financial investments in these is definitely volatile. The ongoing COVID-19 pandemic has certainly proved it.
However, if you are a risk-taker and know about how, where, and when to put your money, investing in the stock market and mutual funds can be extremely rewarding, you can yield so many returns that you can pay off your debts much sooner.
But if you are slightly pensive about investing in stocks, yet you are interested in investing money, term deposits and other government schemes are safer alternatives.
You Want To Create An Emergency Fund
Every working professional should have an emergency fund. In case you suddenly lose your job or have a median emergency, this contingency fund will be your lifesaver. It is like insurance for life's adversities.
Before you embark on your investing journey, set aside a small sum every month from your income toward your emergency fund. You must be wondering how much money is enough for an emergency fund, right?
Calculate your monthly necessities. Ideally, you should have 6-9 months' worth of monthly necessities as your emergency fund. Instead of saving liquid cash, you can rather invest this money in a low-risk, high liquidity mutual fund.
Find The Right Balance
Despite all the arguments in favor or against paying debt off or investment, we would not recommend either. Because investment increases your net worth, debt pulls it down.
So, you should try and find the right balance instead. We come back to the same advice your father or elders gave you, 'don't stop investing despite having debt.' This balance would help you increase your asset, minimise your debt, and fulfil your aspirations and necessities simultaneously.
Follow the rule of a zero-based budget. Here, you must create a budget in a way that at the end of the month or year, you should not have any money lying with you without any purpose.
- Plan your monthly or annual necessities.
- Set aside some money toward your emergency fund
- Divide the remaining money you have left into your financial investment and pay off your debt.
If you follow your budget diligently, you will achieve greater control over your personal finances while boosting your net worth. Thus, you will be able to build substantial financial health for yourself.
But, remember, ultimately, you should do what suits your circumstances the best.
Financial stability is not an easy thing to attain. It takes years of smart decisions. So, if you have some extra cash even after paying for all your expenses, you are lucky.
The best way to ensure you are financially stable is by paying off your debt and investing simultaneously. Thus, you can help you improve your fiscal status and ensure your hard-earned money is not wasted, and fulfil your financial goals.