Budget Basics 101: Why should you pay off debt first and invest later?

One of the biggest questions that comes up with new budgeters is the concept of debt versus investment. Many people do both, even when the financial situation is less than perfect. For example, individuals may have thousands of dollars of debt while maxing out their 401(k) programs at the same time.

The end result is a wash, but not one which is seen immediately. The consequences reveal themselves decades later when said individuals decide to start utilizing the retirement funds they saved. Should they maintain the same debt-investment program, they end up using their retirement funds to pay down said monies owed. This leads to less available to spend on vacations or basic living during later years. This environment is one of the reasons why many older individuals still work beyond their retirement ages.

Why should you pay off debt first and invest later?

Simple — there’s more money available at the end. Let’s go through the process. First, build a small emergency fund then list debts, smallest to largest. At the point the debts are paid off an individual begins to take cash once used for debt payoff and applies it to the emergency fund, building up a three to six month reserve. This is the point where investment should take place.

Not a believer? Let’s take an example. An individual works at a job where they take the maximum amount of money out of their check and apply it to their 401(k). Yes, this helps reduce the amount of taxable gross pay; however, it also reduces the amount of net pay deposited into one’s bank account. The less money put into the bank account means, in most cases, minimum payments made to credit cards and other loans with high interest rates.

At some point in time the individual’s 401(k) reaches $30,000. This seems like a large number even in today’s society. Yet, viewing debt in the same range, it’s $30,000 which could be utilized to pay it all off, giving the individual an investment advantage. Not only can they invest the maximum into a employer-based retirement account, but they can also do so in IRAs or mutual funds, maximizing the amounts deposited in the process.¬†While the debt investor may have a few hundred thousand to use at the point of retirement the individual who pays off debt first and invests later can end up with a few million dollars in their retirement.

If this doesn’t convince you, consider speaking with a financial advisor in your area. Provide them with your current debt and investment portfolio, let them know your retirement goal, and see what they come out with. Odds are it will be the same as you just read in this blog. Gives us a chance to get you on the right financial track.

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