Pay Down Debt or Invest My Money?
FOR IMMEDIATE RELEASE
May 28, 2013
Should I pay
extra on my student loan or invest in a Roth IRA? Build up an emergency savings
fund or pay off my credit card debt? Pay off my mortgage or put more money in
my 401(k) retirement plan? In one form or another, the trending question lately
has been, "Is it better to pay down debt or build up savings and investments?"
real-life questions, the answer is not black and white. The answer is likely to
be based on both objective information as well as personal values. Here are two
questions I suggest asking yourself: "How can you get the most out of your dollars
and what's important to you?"
can you get the most out of your dollar? We tend to be on the lookout for the
"best buy" for our dollar. We know that if we spend our dollar(s) on an item
(such as a movie ticket) that that dollar will not be available to do something
else (like buy dessert). The opportunity cost of the movie ticket is the loss
of buying dessert. In this example, a dollar is worth a dollar because the
choice is, "do I go to the movies tonight or buy dessert tonight?" Both options
take place now.
gets more complex when the choices have longer term impacts and the dollar we
have now may change in value over time. For example, dollars used to buy mutual
fund shares today may increase in value over time. Let's assume the mutual fund
earns 10% over the next year. If you use $100 today to buy mutual fund shares,
at the end of the year you would have $110. This is a $10 gain for your
But if you
use your $100 to buy mutual fund shares, then you cannot use these dollars to
do other things, like pay down credit card debt. Let's assume you have a $100
credit card balance with an annual percentage rate (APR) of 23%. If this credit
card balance is not paid, at the end of the year you would owe $123. (I'm
assuming no minimum balance required or fees to keep this example simple.)
However, if you used your $100 to pay off the credit card balance, you will
save $23 in interest. You have essentially earned a return on your money (gain)
of $23 dollars.
considering an investment with a return of 10% or paying off a debt with an APR
of 23%, you get more from your dollar by paying down the debt. When trying to
decide how to get the most from your dollar over time, first look at the
interest rates charged compared to the possible return on investment.
questions, the tax code makes this comparison more complicated. For example, if
you have a
mortgage on your home and you itemize deductions on your income taxes, the
mortgage interest deduction reduces the amount of taxes you pay. Thus, a home
mortgage loan at 5% interest may actually cost you less than 5%; the amount
will depend on your tax bracket. You may also have a tax-advantage if you
invest money in mutual fund through an employer-sponsored retirement plan such
as a 401(k). If this applies to you, then your return on your dollars invested may
be more than the increase in the value of the mutual fund. Keep in mind your
tax situation when thinking about the opportunity costs of your dollar.
yourself, "What's important to you?" Financial decision-making is more than
adding up numbers. Our personal finances also are influenced by our values and
personalities. Some people feel very strongly that they do not want to carry
debt; this may influence their decision. Others value having emergency savings.
A saving fund can provide financial security, and help avoid taking on new debt
when unexpected expenses come up. Life and, to some extent, investing is
unpredictable. People's comfort with life's unpredictability and their risk
tolerance for the up-and-down of investment returns will also influence their
financial decision-making. That's what makes the question of "what to do with
my money?" both interesting and difficult.
with a decision about what to do with your money, consider how you can get the
most from your dollar. Also, think about your values and what is important to you.
Challenge yourself to think about your long-term goals as well as your
immediate needs. With thoughtful consideration, you can decide wisely how to
use your dollars.
Source: Kathy Sweedler, Extension Educator, Consumer Economics, firstname.lastname@example.org