Life is filled with difficult financial decisions. One of the most difficult situations an investor is faced with is deciding between paying off debt or investing that money in order to see greater wealth in order to make it out in a better position than before. On one hand, if you spend all your money paying off debt, you may not have enough to invest later. Conversely, if you invest too much money, you won’t have enough to pay off your debt. In this blog, we’re going to talk a little bit about the best course of action in this situation. If you’re looking for expert financial advice, speak with a financial advisor today!
Types Of Debt
Not all debt is the same, so it’s important to understand which type you have before making any decisions. You should start by looking at your after-tax return on investing versus your after-tax cost of borrowing. If you have a conventional 30-year mortgage with an interest rate of six percent and are in the top 35 percent tax bracket, your after-tax debt cost will likely be around four percent, since you can deduct mortgage interest from your federal taxes.
Your after-tax return on investment may be higher than your after-tax cost of debt if you have a diversified portfolio of investments with both fixed income and equities. If you own a business, it may be better to invest into your business rather than an outside entity in order to pay off debt. Conversely, if you have less on your investment portfolio, you may need to pay off the debt before making any investments.
Everyone has a different risk tolerance. This will depend heavily on your age, disposable income, lifestyle, and more. If you’re older and have a high disposable income, chances are, you’ll be able to make more risky decisions like investing before paying off debts. However, as a young adult, your room for error is much lower and you’ll want to make investments later in life. As a result, paying off debt is usually a better decision.
Oftentimes, financial advisors will recommend having a monthly debt-to-income ratio of around 30 percent for pretax income in addition to six months of monthly expenses in cash. This “cash cushion” will allow you some wiggle room in case something were to go wrong paying off debt or investing. Cash cushions aren’t just for paying off debt or investing though, you should always consider having these backup funds to fall back on.
Contact Us Today
Guardian Financial Group are your financial advisors in Centerville. We understand that there are a whole host of difficult financial decisions you’ll need to make throughout your life like deciding to pay off debt or invest in hopes of paying off debts more quickly and comfortably. We’re here to make these decisions easier and help secure your financial future. Give us a call today to learn more or schedule a free consultation.