Paying Down Debt vs. Investing vs. Saving

Best tactics to improve your bottom line

Paying down debtCut Card is a tricky process. Not only is it hard finding the money to do so, and it takes a while, but there are different strategies to employ based on your goals. Some people may contemplate saving throughout the year to get a solid nest egg before starting to pay down on that debt. Others opt to invest in hopes to make more money back in order to pay money off more quickly later. There are many considerations when it comes to deciding what to do with your money. Here are just a few of them.

Paying down debt
It’s never a bad idea to work on improving your credit score by paying down debt. Furthermore, there’s no right or wrong way to do so. There are multiple schools of thought regarding how to go about the process:

  • Pay down the loan with the highest interest rate first. Debt with high interest costs you more money over time, so you may want to take care of them primarily.
  • Pay down the loan with the smallest balance first. Clear up many smaller loans more quickly, giving you more money to apply to big loans later.
  • Combine the two approaches. “Average” the methods in a way where you use both approaches at different points in the year. For example, knock out a few of your small loans in a few months and then work on larger interest debt before going back to paying on small loans again.

Regardless of the plan you choose, just make sure to stick with it. However, it is okay to change your approach if your financial circumstances change. Also, don’t use any money saved on frivolous items; keep it in the budget for loan payments only or for the next two options.

Investing
Now, should you pay off those bills using one of the above methods, or should you use your finances instead to invest? This head-to-head debate is not cut and dry. There are many questions to ask regarding the amount of your debt, its interest rate, the possible return on investment and the legitimate likelihood of that return. Neal Frankle, a financial expert writing for Forbes, said that aside from the factual considerations, there are also the emotional aspects at play, such as how you’d feel if you paid off the debt, if you opted not to invest, or if you did and it didn’t work out?

“I have found that these emotional questions are just as important as the financial questions. What good is it to make an otherwise smart financial decision if at the end of the day you are left feeling miserable?” Frankle asked.

There are four inquiries Frankle conjured up to address both the financial and emotional issues:

  • What happens if you decide to pay off the debt and the other investment does well? The answer will likely depend on each unique situation. Would you be giving up the chance of a lifetime to pay down your debt, or are the upsides of the investment actually very limited?
  • What happens if you pay off the debt and the other investment does poorly? Good for you! Do a little dance because you made an amazing choice.
  • What happens if you don’t pay off the debt, make the investment and it turns out well? Be honest—what reasonable outcome can you expect? Will it be enough to cover the interest rate that you are paying on your debt? Will your money double? Be practical in your expectations.
  • What happens if you hold the debt, make the investment and it turns out badly?

What is the risk involved? Can you afford to lose the money at stake and still be stuck with the debt?

By taking a look at how you would feel and how your life would be impacted from two competing alternatives, you can likely make a better decision for your specific situation.

Saving
If investing isn’t for you, maybe you would rather save up some money in a rainy day fund. Actually, some personal finance experts say building a safety net of cash should come before any other money move, according to Casey Bond in U.S. News and World Report.

“The idea is you need to be prepared for financial emergencies — car repair, job loss, etc. — so that you don’t load up on more debt should an unexpected bill arise. Not to mention, it’s psychologically satisfying to see a positive savings account balance,” Bond said.

However, Bond added that feeling good just doesn’t pay the bills. Statistically, you are losing money by saving, as interest rates against debt are much higher than the interest you would be earning in a savings account. The solution, again, is to average the points of view. Strike a balance between saving and paying on debt that is feasible for you and your family.

Regardless of what you choose to do with your money, carefully considering all factors at play in the situation should always be the first step. Hasty decisions regarding your finances are never beneficial.

Used with Permission. Published by IMN Bank Adviser Includes copyrighted material of IMakeNews, Inc. and its suppliers.

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