The first steps in your financial turnaround are easy. Get caught up in your bills. Pay off high interest debt. Build an emergency fund. By the time you do these things, you will already be in much better shape.
The next step is more difficult. At this point, many people still have some low-interest debt, such as: B. Student loan debts, car loans, or mortgages. At the same time, there is also a desire to invest, especially in retirement, but also in other life goals such as buying a home.
You are in control of your expenses and those high interest debts and late fees are a thing of the past. So you have money every month to reach your next goal. But what goal should it be?
Benefits of Paying Off Low Interest Debt
- When you make additional payments on a low-interest debt, you get a guaranteed return on your money – the interest rate. If you make an additional payment now, your total balance will decrease. So if interest is charged on your loan, there will be less interest. You get the money back at the end of the loan in the form of the debt, which goes away sooner so you don’t have to make the final payments.
- If you repay a loan early, your cash flow will improve faster. When you pay off a debt, it means that less of your income is used each month to pay off a debt and more of it can be used for other priorities. For example, you may be able to change your career and get through a time without work much easier.
- Your monthly bills become easier because you have less to worry about. Paying bills becomes less hectic.
- The repayment of debts reduces the «debt stress». Debt is a source of deep stress for many, which can cause all sorts of negative feelings and health effects.
- By reducing debt, the monthly income in retirement is minimized. For example, if you don’t have a mortgage payment every month, the monthly income you need to sustain your life is much less.
Investment advantages for the future
- In the past, responsible investing has produced much better long-term returns than paying off low-interest debt. Even if you invest conservatively, you can expect a 7% annual return on your money over the long term. With more aggressive investments, you can do better. Remember that are long term returns; Most investments that pay off well are much more volatile over a period of less than 10 years.
- When you are young, almost any long-term investment will result in greater financial security later in life. While saving outright for retirement is the most efficient step, investing in other goals like a home or an education also brings value that will increase over the rest of your life and improve your financial situation when you are much older.
- If you decide to invest now, you can change your mind later and do something different with the money. However, changing your mind later can result in a below-expected return on your investment and, depending on the nature of your investment, lead to tax penalties.
- Some types of investments offer tax benefits. For example, if you deposit money into a tax-privileged retirement account like a 401 (k) or an IRA, you will get a lower tax burden today. There are also tax-privileged plans for your child’s education, such as a college 529 savings plan that allows your money to grow tax-free when used for educational purposes.
- If you are stressed about retirement, choosing to set aside a healthy amount of money for retirement can help alleviate that stress.
Which is the right step?
If you have certain life goals that will greatly benefit from having your monthly bills cut significantly in a few years time, such as: For example, if you go back to school, or change careers, or have a child, paying off all of your debts is a good option. Start with additional payments for your car loan, mortgage, and student loan.
However, if you don’t have an urgent goal for the next few years and are more concerned with long-term goals like retirement or paying for a child’s college education, an investment makes more sense for your life situation. When looking to retire, the first thing to do is to consider your tax-privileged retirement options. If you’re looking to save for a child’s college education as well, consider a 529 college savings plan, which is a good choice for most people.
It’s not paying off all of your debts or saving for retirement not correct Choice. When you’re spending less than you make and doing something productive with a difference, you are doing something positive no matter what you choose.
We appreciate your feedback on this article. Contact us at Inquiries@thesimpledollar.com with comments or questions.