When we talk about deciding to invest or pay down debt, many people have many different opinions. While some people will give you a definite answer telling you to do one thing over another, many others will give you an honest but unsatisfying answer of “it depends.” In order to make the best decision for you, here are 5 things to consider:
1. Volatility. Although the market may have had averaged returns of 8 to 10% over the past 30 years, this does not mean your money will increase by 8-10% each year. Some years the returns will go up and some years the value of your investments will go down. Be sure that you’re aware of this fluctuation so you can prepare for it. Investing involves risk. The more risk averse you are, the more it may make sense for you to pay down debt.
2. Inflation. As we’ve all witnessed over the last couple years, most things increase in cost from year to year. Although the standard degree of inflation is about 2-4% per year, there can be years and times (such as the present) in which goods and services increase by nearly 10% in a year. The higher the percentage of inflation, the lesser amount you keep as “real profits.” The purpose of investing is to grow your money, but if inflation is high, then the true value of your money decreases and your profits are worth less. Make smart investments and don’t forget to factor in inflation when you are estimating your investment returns and comparing it to paying down debt.
3. Risk. While it is normal for the value of your investment to fluctuate from year to year, one thing many people don’t always plan for is the risk that they could lose all of their money. Although scary, this is a possibility. Someone could steal your investment, the company you invested in could go bankrupt, the bank could confiscate it, and the value of the business could fall to zero. Some investments make those unfortunate scenarios more likely than others. Be sure that you are considering this if you decide to prioritize investing. Get a true sense for how risky the investment is, realizing that some investments are secured and insured while others are not. Spreading your investment across multiple companies or stocks or real estate helps to mitigate this risk. If you decide to invest, determine how much risk you are willing to take.
4. Incentives. One of the things that can easily sway your decision one way or another when deciding to invest or pay down debt are monetary incentives. If your job gives you a match” to invest money for retirement, then investing makes sense because it helps you take advantage of that incentive. On the other hand, if your largest form of debt is your student loans and you are in some sort of loan forgiveness program that will pay down your debt for you, then taking advantage of that program and providing the minimum debt payment needed in the interim likely makes the most sense. Take a look to see if you are incentivized to do one over the other.
5. Taxes. Although it is nice to invest money and make profits, don’t forget to consider taxes. Those in high-income professions, who are often paying higher shares of state, federal, and FICA taxes must consider this even more. Are there ways you can invest that reduce your taxes? Are there incentives in the tax code that allow you to write off certain debt payments? Which types of investments or debt repayments lower your taxes the most?
Don’t forget to consider these 5 factors when deciding to invest or pay down debt