Should I Pay Off Debt Before Investing?

On the road to financial freedom and following the 5 simple steps (simple, not easy!), it quickly becomes clear that the main vehicle to becoming financially independent and going on early retirement is by investing.

But, how does your current debt factor into that? Do you need to pay off debt before investing? Some of it? All of it? None of it?

Let's break it down.

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The Debt Situation

Here are some quick stats from Balancing Everything:

  • Household debt in the EU is over $7 trillion.
  • The United States household debt is over $14.5 trillion.
  • The average amount owed by American households is $92,727.
  • The median United States household debt is $59,800.
  • California carries the highest family debt in the US.
  • The highest share of the total US household debt comes from mortgages.

This makes it very likely that you currently carry some kind of debt, whether it's ‘simple' credit card debt, study loans, a mortgage, or something else.

It's Not an Or/Or Situation

The question is often posed as an or/or situation. It's either paying off debt, or investing. But rarely both.

You should never put investing on the back burner because you believe you need to first pay off debt, I'll go into reasons why in a minute.

What's Your Monthly Minimum Debt Repayment?

If you've listed all your expenses (like in The Starting Point of the 5 Simple Steps to Financial Freedom), then you know what you should be paying towards your debt(s) every month to not get into any trouble with your debtors.

Always. Keep. Doing. This.

In fact, if your income level is at a point where you're presented with a choice to invest or make that monthly minimum debt repayment, do the repayment. Always do the repayment.

Not doing this is simply setting yourself up for potential (financial) issues later on. You may be taking 2 steps forward at first, but will eventually have to take 1 step back.

Nobody's a winner.

To tackle your debt issue, instead of just having your debtors charge your accounts, have a clear list of all your debt and their respective APR rates, along with your minimum monthly repayments.

Having this listed out somewhere on a spreadsheet of some kind is a great way to start understanding your own personal finances, as well as how you need to navigate on your road to financial freedom.

Keeping Net Worth in Mind

Net worth is the simple equation of: assets – liabilities = net worth.

Obviously, all your debt goes in the liabilities column.

If you haven't paid much, or any, attention to your personal finances, it's very normal that, when you calculate your net worth for the first time, you'll have a negative net worth.

When i started taking my own personal finance journey seriously in November 2020 and listed all of this out myself, I started with a negative net worth of a little under $8,500. At that point, I had a little over $2,000 in the assets column, and close to $11,000 in the liabilities column.

2,332.38 (assets) – 10,816.27 (liabilities) = -$8,483.89 (net worth).

It's important to keep your net worth in mind and track it on a regular basis (I do monthly), because being net worth positive does a lot to your (financial) ego, especially if you've been net worth negative for several years.

I was net worth negative ever since I was old enough to apply for debt, and am so incredibly happy to say that, after almost 12 years (the last 1 of which I've been focused on my own personal finances and strengthening my financial literacy), I'm now net worth positive.

##How did I do it? And how does this factor into the question that you're here for?

Paying Off More Than Necessary

There's such a thing as good and bad debt. But that's an article of its own. I had 0% good debt, and 100% bad debt.

I looked at what my monthly minimum repayments were, because I had them all nicely listed out winkwink, looked at my budget sheet, and realized that, after cutting some unnecessary expenses, I was in a position to pay off more than my debtors required.

Always contact your debtor to see if this is an option for your own specific case, and if that changes anything in terms of interest. I know that this varies wildly country by country, but in a country like Belgium, it's fairly straightforward.

I was in a position to pay off 2-2.5x what was asked of me every single month. This cleared a lot of debt very quickly (but it didn't feel quick in the moment).

So, I was tackling my ‘liabilities' column in a conscious, thought out way that didn't mean having to shoot myself in the foot or go hungry.

But, as I was strengthening my financial literacy, it also became clear that my money can also work for me to…make more money.

However, it couldn't do that since I was giving it all away.

Saving & Investing

That's why I started saving & investing.

Honestly, at first, I only started saving and was still putting off investing any money into the stock market.

That changed when I learned about the Rule of 72 and really took my time to understand the concept of compound interest.

Those resources do a very good and detailed job of explaining what those are, but, essentially it comes down to your money making more money.

But, it can only do that if there's actually money in a brokerage account.

So, I took that amount of what I was able to pay additionally to my debtors (remember, be sure to always keep your minimum monthly repayments) and I divided it up.

I still wanted to pay at least 1.5x to my debtors, cause I don't like the idea and small risk that, as long as I carry any debt, someone can come knocking on my door asking for it.

What I did with the other 0.5 – 1x from before was a simple 80/20 division.

80% of that went to my emergency fund (which I didn't have at that point), and 20% was invested.

As soon as I then reached my emergency fund goals (financial security), it was brought to a 50/50 equation.

Half would go towards my financial vitality objective, and the other half would be invested.

Then, once that financial vitality goal is reached, it was a 10/90 split. Where 10% would go to the emergency fund, and the other 90% would be invested.

This is how I tackle the ‘assets' column.

Wondering where to start investing? Read my Beginner's Guide on Index Investing.

Your Own Personality and Tolerance

My situation might be different from yours. I'm part of a DINK (Double Income No Kids), so my monthly expenses are generally considered low, compared to that of a single household, or of a household with kids.

This also meant that, for me, I was able to get very comfortable, very quickly, of an aggressive savings rate of 40%-50% (meaning that almost half of what I make in income gets distributed either to my savings account or brokerage account).

You may not be in that situation, and, even if you are in that situation, you may not be comfortable with such an aggressive savings rate.

Either is fine. Do whatever you must to be able to not lose sleep at night.

Have you thought about side hustles?

Or about simply trying a month with such an aggressive savings rate as an experiment and see & witness how you'd respond to it? (That's exactly what I did)

Closing Thoughts

To close, ask yourself if you found an answer to your question. I'm not of the opinion, and financial concepts like the Rule of 72, or compound interest, back me up on that, that, anybody needs to be completely debt-free before they start investing.

By attacking the two columns (assets & liabilities), my net worth sees some big monthly changes, all the while building up my emergency fund, investing, and decreasing the risk of any debtor coming to knock on my door.

I'm both paying off more so future-Aki doesn't have to pay off (as much) and I'm setting future-Aki up for a financially secure and vital life, should something happen.

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