Should you Pay Off Debt Or Invest When Heading to Retirement?
We all know that if we want to retire like kings, we have to do two things. One of these is to pay off all of our debts and the second is to invest in our retirement. While there are many ways to go about both, the one big question surrounding the idea of planning for retirement is, “Which should you do first?” Is it best to pay off debt or invest in your future, or is a mix of two the best way to go? The truth is that there is no one size fits all question to this answer.
There Are Different Types Of Debt With Different Costs
The truth is that most Americans have debt. In fact, according to DebtConsolidation.com, between credit cards, mortgages, personal loans and other loans, personal debt is getting closer and closer to it's 10-year high that was reached back in 2008. However, not all debt is high cost debt. Therefore, it's important that you understand the types of debt that you have and the costs associated with them when making the decision with regard to whether it's best to pay your debts off or invest first. Here are the most common types of debt ranging by general priority (in your unique case, some types of debt may be higher or lower cost)
- Credit Card Debt – In general, credit card debt is the highest priority debt. In most cases, credit cards come with high interest rates and could include annual and other fees.
- Personal Loans – Personal loans, also known as personal lines of credit, are also known to come with relatively high interest rates, making them high-cost debts.
- Secured Loans – Secured loans are loans that are secured by property. These include auto loans, RV loans, boat loans and more. Because there is security in the asset the loan was used to purchase, risks associated with these loans are lower, meaning that they will come with lower interest rates and costs than personal loans and credit cards in general.
- Student Loans – Student loans are secured through the strength and security of the United States government. Therefore, these loans are known to be low interest, low cost loans.
- Mortgages – Finally, mortgages, or home loans tend to come with the lowest interest and lowest costs. Because these loans are secured by an asset that is known to gain in value, the home the mortgage was used to purchase, the cost of these loans is generally as low as they can get.
It's Important To Understand Your Debts
Before you can make the decision with regard to whether you should pay off your debts or invest first, it's important to get a good idea of what your debts are costing you. To do so, you're going to want to create a debt profile. Your debt profile should include the total owed on each account, interest rate charged, annual fees, and any other costs. Once you have all of the data, figure out exactly what rate of loss is included in each debt on an annual basis. This should include interest and all fees associated with each debt.
Weigh The Options
Now, it's time to decide if it's best to pay your debts off first or start to invest. Ultimately, if you can earn more money investing than you can paying debts off, it's best to pay minimums on debts and focus on investing for your future. However, if your debt costs you more than you can earn in the market, it's best to pay your debts off first.
While it is best to compare how much you pay for your debts to how much money you actually earn in the market, not everyone can do that. If you have never invested, it may be best to go with the average rate of return on the S&P 500. Currently, the average rate of return on the S&P 500 is approximately 10%. Therefore, if you don't have any data from your own investing activities, it's a good idea to focus on paying off debts that cost more than 10% a year before you start investing. Once you have debts that cost less than you earn in the market, it's time to start paying minimum payments and investing in your future!