In personal finance, there are two schools of thought about the best way to make use of extra cash. One side says that you should always pay off your debt, because this will save you money on interest payments. The other side says that you should invest your money, to grow it for the future. Which is best? There is no answer that is right for everybody, but here are some things to consider.
Paying off debt
Debt includes mortgage loans, auto loans, student loans, personal and business loans, credit cards, and more. Debt January be either secured or unsecured, and each debt will have its own interest rate and payment terms. The interest that you have to pay is the cost of financing that debt. When you pay off a debt, it is like getting that interest back you would have paid, like getting a guaranteed rate of return.
You should always focus on paying off the debt with the highest interest rates first. Whenever you are struggling to make your payments due to high debt, you should always strive to pay down that debt and get your payments to a more manageable level before using your funds to invest.
Come up with a strategic spending plan
Grab a piece of paper and note down the revenue you have left after you’ve paid out all your monthly expenses. Thus you’ll know how much money can spend in 30 days without fearing that your bills will pile up. Limit your shopping sprees to one time per week, make a list with essentials. Stick to that list if you want to save up.
Now it’s time to gather some money to pay off debt. Can you afford to spare $50 a week? How about $100? Put the extra money into a savings account and leave it there. Each time you have more, add it to that account. Be rational and stick to your spending plan.
Investing your money
Investing gives you a chance to grow your money and let it work for you. This is the only way that most people can build a nest egg to fund their retirement. If your debt is under control, then it can be advantageous to allocate some of your cash to investments so you can plan for the future, even as you use other funds to continue paying off your debt. If you use all of your money to pay down your debt, then you January not have enough funds when you retire.
What happens if you lose your job, or face unexpected medical bills? This is where having a reserve of cash can save the day. Most financial advisors recommend that individuals should have enough cash saved up to cover about 6 months of their normal monthly expenses. If rough events come up, this can help you weather them without having to sell investments at an unfavorable time. For self-employed people, that cash reserve is even more important. Without the funds to carry you through a difficult time, the dream of entrepreneurship January come to an end.
A hybrid strategy
A combination of the above approaches works well for many people. First, save up enough cash to provide a safety net in case of unforeseen situations and expenses. Next, pay off your credit card debt, which is typically the highest interest rate form of debt.
After this, look at your other debt, and evaluate the interest rates you’re paying vs. the estimated rate of return you could get by investing that money. Keep in mind that mortgage interest is tax deductible, which means that the real after-tax rate you’re paying is less than the basic interest rate on the mortgage. Also consider the benefits of any company match on a 401K plan for retirement investments.
Believe it or not, investing your money in something that yields returns is a sensible way to pay off debt. However, try not to take unnecessary risks. Before spending money that you don’t have, consult with a financial advisor and decide on a type of investment. Ask for clearance, talk about the funds you have available, and don’t get your hopes up. It’s really important to be patient if you want to invest to pay off debt, and still have some money left.
By Jason Phillips and WineInvestment.com!