Financial experts always highlight the same advice to people looking to get on track with their money and build their net worth: invest and pay off debt. Often they pair the two, advising people to do both. But in which order? Which should you prioritize and why? Additionally, why is it so important to do both?
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To get to the bottom of these questions, GOBankingRates chatted with a number of financial experts. Here’s what they told us.
You Can Take a Two-Fold Approach
The most popular advice among financial experts may be surprising: tackle debt and invest at the same time.
“Instead of doing one first, I believe in a two-fold approach, in which you pay down a healthy portion of your debt while allocating that same amount in a low-cost S&P 500 index fund with ‘only’ an average, long-term return of 10%,” said Paul Heys, financial advisor at Investorship.
“Eventually, the debt balance will be gone, and you can increase the regular allocation to build long-term wealth,” Heys said. “But, if you do not want to take that chance, it depends on the situation. If you can earn more on your investments than what your debts cost you in terms of interest, then you should invest first. Paying off debt is very important, but you need to invest in your future.”
Laura Sterling, VP of marketing at Georgia’s Own Credit Union, agrees with Heys.
“As a rule of thumb, you should try to pay off debt and invest together,” Sterling said. “While paying off debt can free up your money, the earlier you begin investing the better off you’ll be in the long run. Investing even a little each month can help. However, if you have high-interest-rate debt or can’t afford to do both now, paying off debt should be your first priority.”
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Know These Numbers If You’re Choosing Between Paying Off Debt and Investing
In order to determine which is truly the best decision for your overall finances, you must factor in interest rates on both your current debts and your future investments.
“You only need to know two numbers when making this decision: your debt’s interest rate and the rate of return on the investment you’re considering,” said Tony Molina, CPA, head of community at Wealthfront. “If the potential returns on your investment are higher than your debt’s interest rate, you should prioritize investing. If the interest rate on your debt is actually higher, you should pay down that debt.”
Why Tackling Debt Is So Important
It’s worth discussing why tackling debt is so incredibly important. It’s not just because it’s so stressful; it can actually be ruinous for your financial health.
“Paying off debt is crucial to your financial well-being,” said Steve Sexton, retirement planning expert at Sexton Advisory Group. “The longer you carry debt, the more money you’re paying in interest — which means less money you have to allocate toward your financial goals, including your savings, investments, retirement, buying a home, etc.”
Additionally, paying down debt opens room for you to invest more aggressively and ultimately build up your net worth.
“Albert Einstein is rumored to have said, ‘Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it,'” said Robert R. Johnson, PhD, CFA, CAIA, professor of finance, Heider College of Business, Creighton University. “Whether he actually said it or not is irrelevant. But, people can help put their investment house in order by reducing debt and acquiring assets that grow in value over time.”
Why Investing Is So Important
It’s equally important to invest as it is to pay off debt. Why? For one, it helps you weather periods of high inflation.
“Investing your money is so important because it can help you beat inflation,” said Erika Kullberg, a personal finance expert and the founder at Erika.com.
“Let’s say you keep all of your savings in a savings account,” Kullberg said. “That’s a great and safe place to start, but typically, your money won’t earn enough interest to outpace inflation. This means that if you hold onto your savings for many years — as you should — the value of that money actually decreases. This is why it’s so important to invest your retirement savings in a 401(k) or IRA account. Imagine if you saved $10,000 for retirement now but won’t retire for another 40 years. Chances are, that money won’t stretch nearly as far in the future.”
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This article originally appeared on GOBankingRates.com: Financial Experts: Invest or Pay Off Debt? Which One You Should Do First
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