Where Should Your Financial Focus Lie: Reducing Debt, Saving or Investing?
Blogger Alfred Edmond Jr. recently wrote a post for Black Enterprise explaining this is bit of a trick question, as the three practices factor into each other more than you would think.
” The fact is, paying down debt is an investment—in fact, everything you do with your money is. The only question is what the returns will be on the investment choices you make with your money,” he writes. He believes that in fact, paying down debt could be the best investment you can make, with each dollar spent freeing up funds for future savings and assets. How can debt reduction be the “only investment with guaranteed returns” as he puts it? He names two major reasons.
The first is that the act of paying down debt allows for more money to go towards future financial goals, such as making a down payment on a home, financing a college education, or launching a business. At the moment, credit card debt has reached an average of $8,640 debt per household. In some cases, this debt may have been a worthy choice, like taking a business trip, but often, it is tied up with depreciating assets.
The second reason is that for each dollar of debt paid, that money is freed from being tied up in paying interest in fees. Edmond Jr. cites the example of ” if you’re paying $100 a month on that $8,000 balance, with an APR of 15%, you’ll pay nearly $2,400 in interest payments over the next two years alone. Paying down the debt immediately frees up that money for other uses, ranging from shoring up your emergency savings to making larger contributions to your 401(k) or other retirement savings accounts.” Perhaps the mindset should be less that paying debt is keeping you from making investments so much as it is that paying debt is working you to finance future investments. Compared to a mutual fund where performance can shift, these results do not chance, hence Edmond Jr.’s conclusion that there is no case of diminishing returns.
When laying down a plan for paying down debt, Edmond Jr. explains that his bottom line is that “You must pay yourself first, starting with building up an emergency fund equal to at least 9 months of your annual household expenses, in case of loss or extended interruption of income.” The second priority after this is that you need to save in retirement. But beyond this, paying down high-interest debt should be a top priority, allowing you to free up more money to build savings and an investment portfolio over time.