It’s a long-standing issue and the subject of much debate: If you have extra money, which should you do first – pay off debt or invest?
In fact, you have three options. For example:
You can use extra money to pay off debt. Whether you should pay off a mortgage, a car loan, credit card balances or a family member’s student loan before investing depends on the interest rate of the debt. The “magic number” will vary by individual, but broadly speaking, if the interest rate is higher than 10% you should pay off the debt. Why? Because you are unlikely to get that high a return on a stock market investment over the long term.
Use any extra money to invest. If, however, the interest rate on your debt is low, you may want to consider investing before you pay off your debt.
Generally speaking, if the interest rate is lower than 5% (as it could be on your mortgage, for example) you may be better served by investing your extra money in stocks or stock mutual funds.
What about bonds? In fact, bonds may not be the ideal investment, as their yield is now low.
So with an interest rate on your mortgage of, say, 4%, purchasing a bond or bond fund that yields approximately 2% wouldn’t make sense.
Use some of the extra money to pay off debt, and some to invest. You could also use a portion of your extra money to pay down your debt, and invest the remainder in stocks. Perhaps start at 50/50, then adjust based on stock-market performance. For example, in a rising market, you might put 75% of your extra money toward stocks and use 25% to pay off debt.
For many, this option’s a win-win. But just to be sure, ask your advisor.
Note: This material has been prepared for informational purposes only, and is not intended to provide financial advice.