Should I Invest If I Have Debt? The Dos and Don’ts for Beginners

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If you have debt and are unsure whether to invest, you’re not alone. An estimated 77% of Americans are tackling debt, with 45.4% burdened by high-interest credit cards, yet we all know investments need time to grow.

So how do you balance these financial goals?

Is it possible to chip away at debt while also building wealth?

This dilemma is common. By considering the benefits and consequences of each action, you can determine which choice is best for you. Remember, personal finance is just that: personal. While other “experts” may tell you to put investing on hold until you’re completely out of debt, there are always exceptions to the rule.

Paying Off Debt vs. Investing: Always Start with Your Budget

Before making a decision, the first step is to scrutinize your budget. It’s the cornerstone of financial freedom.

Without a clear understanding of where your money is going each month, you risk repeating the cycles that led to debt in the first place. Addressing the root causes of your debt is crucial; otherwise, the problem may only worsen.

A well-planned budget helps ensure you don’t stretch yourself too thin, divvying funds wisely between debt reduction and investment opportunities.

Simply put, securing your budget is the groundwork for making informed decisions. Without this foundation, any choice to pay down debt or invest could be premature, potentially jeopardizing your path to financial stability.

So, take a hard look at your budget first — it's the critical step towards making choices that align with your goals. If you don’t know where to start, I previously outlined 9 steps for financial freedom.

Benefits of Paying Off Debt First

Choosing to pay off debt before investing offers several compelling benefits. Here’s why making debt repayment your priority can be a wise decision:

Peace of Mind: Debt, especially high-interest debt, can be a constant source of anxiety. Clearing it not only frees up your budget but also your mental space, allowing you to focus on future goals with clarity.
Improved Credit Score: Consistently paying down debt boosts your credit score, a crucial factor that affects your ability to secure loans with favorable terms in the future.
Increased Financial Flexibility: Without monthly debt payments, you have more freedom to allocate funds towards investments, emergencies, or other financial goals.
Cost Savings: The interest on debt often exceeds what you could earn from investments, particularly safe ones. By paying off debt, you effectively earn the interest rate you would otherwise pay. Credit cards, for example, have an average interest rate of 22.8%, which is well above the S&P’s 10.26% historical rate of return.

Focusing on debt first paves the way for a healthier financial future, laying a solid foundation for wealth building without the drag of high interest costs.

Benefits of Investing with Debt

Investing while carrying debt might seem counterintuitive, but it can have its advantages, especially if you're strategic about it. Here are some key benefits:

Potential for Higher Returns: Investments, particularly in the stock market or real estate, can offer returns that outpace the interest rates on debts like student loans. This discrepancy can lead to net positive growth of your wealth.
Compounding Interest: The power of compounding cannot be overstated. Starting early allows your investments more time to grow, leveraging the ability of your assets to generate earnings, which are then reinvested to generate their own earnings.
Diversification of Assets: While paying off debt is a guaranteed return on investment (you're saving on future interest payments), investing can diversify your portfolio. This could protect you from different financial risks and offer opportunities for wealth expansion in ways debt repayment alone cannot.
Retirement Savings: Contributing to retirement accounts, especially if there's an employer match, is an opportunity too good to miss. This is essentially free money, contributing to your long-term financial health far beyond the immediate impact of debt repayment.

Investing with debt requires careful consideration of the interest rates you're paying versus the returns you're likely to see. But for those who navigate this path wisely, the long-term benefits can significantly bolster financial resilience and growth.

3 Questions to Ask Yourself to Decide Between Paying Off Debt vs. Investing

Deciding whether to prioritize paying off debt or investing requires a complete understanding of your personal financial situation. Here are three critical questions to guide this decision:

What is the interest rate on my debt compared to the potential return on investments?

Assess the cost of your debt versus potential investment gains. If your debt carries a high-interest rate, it might be better to pay it off quickly. However, if the interest is low and you believe your investments could outperform it, then it’s okay to consider investing.

How do I emotionally feel about debt?

Your personal comfort level with debt is crucial. Some people might prefer the peace of mind that comes from being debt-free, while others are comfortable carrying some debt if it means they can grow their investments. Reflect on your risk tolerance and psychological comfort with debt.

What are my financial goals and timeline?

Consider your short-term and long-term financial objectives. If you're saving for a goal that's many years away, such as retirement, starting to invest early can be beneficial. But if you have pressing financial needs or goals in the near term, focusing on debt might be more impactful, as it can free up your financial resources.

By answering these questions honestly, you can tailor a strategy that aligns with your financial situation, goals, and risk tolerance, making it easier to navigate the path between debt repayment and investing.

Key Takeaways: Dos and Don’ts

Do:

Evaluate Your Interest Rates: Compare the interest rates on your debt with the potential return on investments. If your debt's interest is significantly higher, focusing on repayment might be the wiser choice.
Assess Your Financial Stability: Ensure you have an emergency fund and a stable income. Investing without this safety net can amplify financial risks, especially when carrying debt.
Consider Your Financial Goals: Reflect on your long-term objectives. Are you aiming for financial freedom, saving for retirement, or building an emergency fund? Your goals can guide whether to prioritize debt repayment or investment.

Don't:

Neglect High-Interest Debt: High-interest debts, especially credit card debts, can quickly spiral. Prioritize these repayments to avoid compounding interest charges.
Overlook Retirement Contributions: Missing out on employer-matched retirement contributions is leaving free money on the table. Even small contributions can grow significantly over time.
Underestimate the Power of a Budget: Without a solid budget, it's challenging to make informed decisions about debt repayment versus investing. A budget is your roadmap to financial health, guiding you on how much you can afford to allocate towards each goal.

If you don’t already have a budget, I recommend following these 9 steps for financial freedom. And if you need inspiration or encouragement any time along your journey, I welcome you to join The Budget Mom Family on Facebook!