I love when people ask me whether they should pay down debt or get started investing. This means they are being intentional with their money and building wealth! In my opinion someone taking positive steps in any direction is better than nothing. For this reason, I would never shoot down someone’s plan. However, if they are asking for my personal advice I always recommend paying off the debt first. Once your debt is gone you will feel supercharged. You will be able to invest more money and have options as to what direction your personal life will go next.
3 Reasons To Pay Off Your Debt Before Investing
1. Free up your cash flow.
Once your debt is paid off you will have provided yourself with a permanent raise. Every month that you work moving forward you will be able to choose what you do with the money you earn. As of right now your debtors have a contract that tells you what to do with your paycheck. Regardless of if you stay employed or your investments keep providing returns your debtor will be waiting for their payment each month! Free yourself of this burden and keep the cash you make each month.
2. Take the risk-free win.
Many talk about using debt as leverage to get ahead. The idea is you take a loan at say 5% and invest and get a return at 8%. In this scenario you are making a 3% return using other people’s money, brilliant! Although in theory this is true it does not consider the amount of risk you are taking to earn your return. When you pay off your debt you are getting a guaranteed return, you will not pay any more interest on the loan value once it is repaid.
That is why it is so important to pay down any high interest-bearing debt. Don’t get fooled by “cheap money” either although rates are historically low today, values of assets are historically high. This means you are locking in a fat debt obligation regardless of if values revert to the mean over time. Make sure you take the easy win and lock in your guaranteed return when you are still in debt.
3. When a recession hits you will not regret having paid down debt.
It is starting to feel a bit nutty out here lately. I enjoyed Financial Samurai’s post that it is starting to feel like 2007 again. Personally in 2007 I was flying off to Australia with 5K in my pocket and not a care in the world or the realization that things were melting down around me. Therefore, I have no point of reference as to what it was like ahead of the downturn in the work and investing world.
Lately however it feels to me as though it might have before the last downturn. Over night people are becoming Bitcoin millionaires, housing is out of control, and the no one can lose mentality is back in full force. Those who are flying high taking risks today can be wiped out if they are not well positioned tomorrow. There is a reason companies with “clean balance sheets” or low debt obligations are more valuable than those that are loaded down with debt. Create your own “clean balance sheet” and make sure you can handle anything life throws at you.
Once you have paid off your debts you will be able to take more risks investing and swing for the fences. Until that point I think everyone should position themselves to succeed by ditching the debt. Don’t feel like you are missing out there will always be another investing opportunity.
What Are Your Thoughts?
- What types of debt do you hold today?
- If you are debt free do you regret it?
- What is your plan to pay off your debt?