Should You Invest or Pay Off Debt First?
Deciding whether to invest or pay off debt first can be difficult. Both are responsible choices that help attain your financial goals.
The Rule of 6%, described below, can help determine whether to invest or pay off debt first. The suggested adjustments can also benefit your situation.
The Rule of 6%
If you have at least 10 years before retirement, are investing in a balanced portfolio with approximately a 50% allocation to stocks, and are investing in a tax-advantaged account, such as a 401(k), 403(b), or IRA:
Consider paying down debt with an interest rate of 6% or higher before investing.
Consider investing before paying off debt if the interest rate is below 6%.
If you have lower interest rates on debt, your long-term investment returns should be significantly higher than what you would receive by paying off your debt faster.
Tips to Adjust the 6% Rule
The 6% Rule generally applies to a balanced asset allocation. However, you might consider a higher or lower threshold if you invest more or less aggressively.
For instance, if you are 35 years old and investing for retirement in a tax-advantaged account, you might make the following adjustments to the 6% Rule:
If your asset allocation is less aggressive: Consider paying off debt with an interest rate of 5% or higher before investing. An investment mix with a lower allocation to stocks might result in slightly lower long-term returns on average. Therefore, you could come out ahead by paying down debt first.
If your asset allocation is more aggressive: Consider investing before paying off debt with an interest rate of 7% or higher. A greater allocation to stocks can result in higher expected returns. As a result, you could come out ahead by investing over the long term before paying down debt.
Additional Steps to Take
Take the following steps while following the Rule of 6%:
Pay the minimum on each debt.
Build your emergency fund.
Capture any employer match on your 401(k) or 403(b) account.
Pay off credit card debt.
The above tasks are essential because paying the minimum on each debt, saving for emergencies, and eliminating credit card debt help protect your credit score and create financial security.
*This information is for educational purposes only.
Do you plan to invest or pay off debt first? Let me know in the comments!
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