Financial Priorities: Should You Pay Off Debt or Invest First?

One of the first issues consumers encounter when creating their budgets and financial plans is a conflict in goals. Most want to invest for retirement, and most want to pay off debts — but there’s only so much money to go around. So which should be done first? The answer to this question is… it depends partially on the type of investment, and it also depends partially on the type of debt to be paid off.

Below we’ll discuss which debts should be paid off as quickly as possible, which investments should be considered first priority, and of course why an emergency fund should be one of the basic financial goals of every personal financial plan.

Types of Debt

Not all debts should be considered equal. Some debts — like credit card debt — ought to be paid off as quickly as at all possible. Other debts — like mortgage loans — can be affordably paid off over time. Credit card interest rates are usually in the 14-17% range on average, and are absolutely detrimental to one’s net worth.

If one has 10k in credit card debt, it would be very difficult to counteract its affect one one’s net worth with 10k in stock investment, bond investments, or any other investments. Because of the high current interest rates of credit cards, they should be one of the first priorities for individuals wanting to make the best financial choice.

Even if someone is a first-rate stock picker, they would have be extremely, extremely good to average returns over what credit cards are unearning. In terms of net worth, it’s almost always a good idea to pay off credit card debt.

But not all debt is as destructive. For example, a mortgage with a 30-year fixed interest rate of 4% probably isn’t a first priority debt. Putting money into index stock funds or high-paying dividend stocks via a Roth IRA is probably a better choice than paying extra payments on the mortgage. The debt might last longer, but your net worth will increase faster with the mortgage plus an investment rather than no investment and a smaller mortgage.

Types of Investments

Just as not all debts are the same, not all investments are the same either. For example, putting money into short-term bonds is probably never going to earn a higher interest rate than most debts.

In general, it simply depends on the types of debts and investments being considered. Credit card debt should almost always be paid off or renegotiated in a manner that can decrease their interest rates (through a debt snowball or debt consolidation loan, for example).  Investments that are safe and low-interest should be considered cautiously when one has high-interest debt.

In the end, the goal is to increase your net worth at the fastest rate possible without overly-risking your financial security. For most, this means paying off credit cards, putting money into fairly conservative funds that are high in stocks, and paying off mortgages on time every month.

Once your debt/investment plan is created, stick to it and your financial situation should continue to improve on a monthly level.