The other day I posted about When to Open a Roth IRA, and I got an interesting comment from Jason at Work, Save, Live. He wanted to start investing in a Roth IRA for many of the reasons I mentioned in the article, but he hadn’t started yet because he’s working his way out of debt.
My reply was that I think you can balance investing with paying down debt. However, the more I thought about it, the more I realized that my response doesn’t really apply in all situations. Here are some thoughts on investing while paying down debt and when it makes sense to invest, and when it makes better sense to pay down your debt instead.
When You Should Focus on Debt and Avoid Investing
There are quite a few circumstances when you should focus on paying down debt instead of investing. The biggest example I can think of when you want to pay off debt first is when your debt is costing you a higher interest rate than what you would earn in the stock market.
Think of it like this: if you are a conservative investor, you may only earn 3-4% in the market this year. If you are more aggressive, you may push 6-8%. However, if you have debts that are charging you an interest rate of, say 10%, you would be better off paying off the debt first, and then investing.
When Debt and Investing are Okay
I’m still a firm believer that there are situations when having debt and investing are compatible. But once again, it goes back to the formula above – if you can earn more in the market than your debt is costing you.
For example, if you have federal student loan debt, your interest rate is probably 6.8%. However, you get to deduct your student loan interest from your taxes, so your effective student loan debt rate may only be around 4%. You can probably achieve a return equal or greater to this in the stock market, so it may be wise to just make regular student loan payments, and contribute to an investment account, like an IRA.
What are your thoughts on investing and debt? Should you invest if you’re in debt?