Investing has become far easier over the past decade. With apps like Cash and Robinhood, first-time investing is possible at the tap of a screen. While this increased level of access to investing can be a beautiful thing, it does have some drawbacks. And one of the leading drawbacks is choosing to make investments rather than paying down high-interest debts.
It can be tempting to invest when you see other people earning huge gains with very little work required. But getting in on the investing action sometimes isn’t the smartest move financially. If you’re wondering whether or not your debt means you should wait to invest, read on. This article will cover the questions you should ask before investing if you have debt.
How Much Debt Is Acceptable If You Want To Invest?
One thing to consider is how much debt you have. Is it going to take many years to pay it off, such as with a home loan? If your debt has a term of ten or more years, it might still make sense to start investing. With that said, there are a range of other factors to consider. The way your debt is structured and your interest rates, along with numerous aspects of your investment, all play a part in whether or not you should invest.
What Type Of Debt Do You Have?
Perhaps the most crucial question to answer is what type of debt you have. How is your debt repayment structured? If the debt has a very low-interest rate and it’s tax-deductible, as with many home loans, it’s probably still wise to invest. Regardless of the amount of debt, if the effective interest rate is far below your likely returns on investment, there’s a good chance it’s smart to invest. When debt has tax benefits that allow you to offset some or all of the interest costs, there’s a much better case for investing.
In contrast, revolving debt, such as with personal credit cards, works much differently. If you carry a balance from month to month, you often wind up paying interest charges on the interest that was added to your account the month before. Paying the minimum payment on credit cards results in costly interest charges over time, enough to totally erode investment gains. What this means is you should almost always prioritize paying off credit card debt over becoming a new investor.
What Interest Rate Are You Paying On Your Current Debt?
Beyond the way in which the interest is repaid, what are the rates you’re paying on your debts? Some credit card debt can have rates as high as 30% or more depending on your state. With rates this high, you’re almost certainly better off paying down those debts before you start allocating your income to investing. On average, stock market investments return around 12% or less, and these come with a significant risk of losing all of your hard-earned money.
Comparatively, paying off debt that has a 30% rate on a revolving balance is like a guaranteed return on your money. When you wipe out high-interest debts, you lock in future savings that go directly into your pocket. Even better, that money is available to you now, rather than many years from now like investments.
What Kind Of Returns Are You Actually Going To Earn On The Investment?
While most stock investments will only deliver around a 12% return, there are other types of investments out there that have much higher potential. One example is real estate investing when you have specialized knowledge about how to flip houses. People with contracting backgrounds and a solid network of partners to invest can make relatively fast returns, helping them pay down large chunks of debt once their project sells.
Another example is someone who owns a business. If investing in the business will enable it to generate more income each month, this could be a better option than paying down debts. One way to help decide is whether or not the debt is hurting your ability to earn more money with your business. If so, you should work to pay down the debt before anything else.
How Liquid Is The Investment?
One key factor when choosing whether or not to invest or pay off debt is how liquid the potential investment is. Will you be able to cash out at any time without taking a huge loss or paying big tax penalties? Or will your investment be locked up for years, such as with a certificate of deposit or buying a rental home. Consider what it will look like if you suddenly need to come up with extra money and all of it is tied up in investments. Would it be better if your debts were paid off so you’d have the freedom to use credit in emergency cases?
How Certain Are The Returns On Your Investment?
Few investments are guaranteed. And in general, the lower the risk, the lower the returns. If you’re banking on high returns from risky investment opportunities, think about what will happen if the deal goes south. Will you still be able to repay your debts if you lose all of your investment capital? No investment should ever extend your finances beyond your ability to repay your debts as promised. Otherwise, you risk your credit and possibly even your assets like a home or a car.
Do You Have In-Depth Knowledge That Improves Your Odds Of Positive Investment Returns?
If you’re an expert in a certain field that presents an opportunity for direct investment, it could be the best move. In rising real estate markets, experts in home renovations and local markets could benefit by investing instead of paying off debt. Another example is in the startup world, where an imminent IPO for your employer is on the horizon.
Do You Need Debt Relief So You Can Start Investing?
When you have high-interest debts that are costing you hundreds in monthly payments, your ability to invest is restricted heavily. Alleviate Financial can help you become debt-free faster so you can capitalize on investment opportunities. Get started today!