Should you pay off your debt?
It's one of the biggest money dilemmas that people face, and the wrong move could cost you tens of thousands, because you've probably heard two completely opposite rules.
Pay off everything first or start investing or you're falling behind.
But the problem is that both can be wrong depending on your situation.
I'm Nisha, a former investment banker turned a financial educator.
And in this video, I'm going to show you exactly how to decide, so you don't waste any more money, lose any more time or lock yourself into the wrong path.
So first, we need to talk about why so many people believe you need to be debt free to invest.
Why should you pay off your debt first?
Well, this has a lot to do with the cost of borrowing.
In the US, the average interest rate on a credit card has been hovering around 24 12 on a personal loan and 6 on a mortgage.
So let's say you borrowed $5,000 on a credit card at 24% and didn't pay it off for a year.
You'd owe around 1200 in interest alone, potentially more, and that's without spending another dollar.
A $10,000 personal loan then at 12% would cost you about $1,200 in interest over a year.
And a $300,000 mortgage at 6% would cost you about $347,000 in interest over a 30-year term.
Meaning you're spending more on just the interest than you actually borrowed in the first place.
So it's super easy to see why so many people believe in paying down debt before investing.
But following this advice without asking the right questions, without running the numbers and without working out whether it actually makes sense for you personally can sometimes backfire, potentially leaving you with far less money than if you just started investing today.
So let's talk about how waiting to invest can cost you thousands and, to show you what i mean, we need to talk about the stock market.
When you invest in stocks, the value of your investments can go up and down over time.
But on average, the stock market as a whole has historically grown by around 8 a year, after inflation.
And the best part is that these results can compound over time.
So if you invested $100 and earned 8% in your first year, you'd have 108 by the end of it.
In the second year.
If we assume you got that same return, you wouldn't just earn 8 on your original 100.
You'd earn it on the full $108, therefore giving you $116.64.
That process keeps repeating with your gains, generating their own gains year after year.
And this is where the difference between starting now and waiting just a few years can become enormous.
So now let's imagine you invest 200 a month into a broad stock market index fund that tracks global stocks, or something like the SP 500, which is an index that tracks the share prices of 500 of the largest publicly traded companies in the US.
After 10 years, you'll have contributed 24,000 in total.
But thanks to compounding, your investments could be worth around 36000, meaning 12000 of that is pure growth.
After 20 years, your total contributions would be 48000, but your portfolio could be worth roughly 115000, a gain of around 66000 just from returns.
And after 30 years you'd have contributed 72000 in total.
Yet your investment could grow to around 280000.
That's more than 200 000 of that.
That is coming from the growth alone.
And if you're new to these investment calculators, all these numbers can seem pretty overwhelming at first.
But it can be super, super satisfying once you get the hang of it.
You could plug those numbers in for yourself and after a while you start to see just how powerful the stock market can be, because it gets to a point where your money is doing all the hard work for you and continuing to grow in the background, even if you're no longer contributing yourself.
And what a lot of people don't realize is that time is actually the most important factor here.
The longer you wait to start investing, the harder it can be to make up for it later.
So how do you work out which strategy to prioritize?
There's no one size fits all answer here.
But as I'm about to explain, there are some simple calculations you can do to get started.
So how do you decide what makes the most sense?
First, all you need to do is compare how expensive your debt is with how much you could realistically make by investing.
So if you have a credit card charging 20 interest, for example, you'll save more by paying that off early than you could reasonably expect to make in the stock market.
You can lock those savings in immediately and not have the risks that come with investing.
So if your debt is costing you more than you're likely to earn by investing, paying it off usually makes the most sense.
But if the interest rate on your debt is lower, say around 4 or 5, the right answer isn't quite so straightforward.
To show you what I mean, let's imagine you have 10000 of debt at 5 and your minimum payment is 150 a month.
At that rate, if you only paid the minimum, you'd be in debt for roughly six and a half years and you'd pay about 1700 in interest over that period.
This assumes interest is calculated monthly.
The rate stays the same and you make every payment on time.
But what if you spent those six and a half years doing things a little differently?
Let's say you have an extra 200 a month you can afford to put towards your finances and you're trying to work out what to prioritize debt repayment or investing.
So strategy A, let's go through this.
This is focusing on the debt first and then investing.
So let's say you put the full 350 a month towards the debt.
That clears the balance in around two and a half years and sees you paying roughly 650 to 700 in interest.
Then once the debt is gone, you invest the full 350 a month for the remaining four years or so.
By the end of the six and a half year period.
That would leave you with an investment of around 19000.
Then we have strategy B, pay the minimum and invest from day one.
This time you keep paying the 150 minimum on the debt, but you invest the extra 200 a month straight away in a low cost index fund, earning an average of eight percent a year.
If you do that for the full six and a half years assuming that eight percent average over that six and a half years while continuing to pay down the debt in the background, over time your investments could grow to around twenty thousand and you'd play closer to 1700 in interest on the debt.
So at a 5% interest rate, the difference between these two strategies is actually pretty small.
Strategy A saves you roughly 1000 in interest, but strategy B gives your investments more time to grow.
And in this case, those two effects mostly cancel each other out.
And that's exactly why this decision is so confusing for so many people.
When debt interest is relatively low, the mass just doesn't give a very clear, simple winner.
Small changes to assumptions like how long you invest, for what returns you earn or how consistent you are, can easily tip the balance either way.
Something else to keep in mind is that investing isn't free and it isn't guaranteed most platforms.
They do charge small fees which can reduce your returns over time, And the 8 figure we've used is an average.
Some years you might earn more, some you might earn less.
So, if you do decide to invest, it's worth choosing a low-cost platform, and remind yourself that your investments can fluctuate over time, specifically during the short term.
Now compare that to high interest rate debt.
If this was a credit card charging 20%, the calculation changes completely.
At that rate, a 10,000 balance costs you around 2,000 a year in interest alone.
So in that case, paying off the debt first almost always makes more sense, because the interest you're avoiding is far, far higher than what you can reasonably expect to earn by investing, and it's guaranteed.
Which is why, when you're dealing with lower interest rates, the right choice for you isn't just about numbers.
It's also about how comfortable you feel carrying debt, how likely you are to invest consistently and what helps you sleep at night.
Now being able to work through calculations like this and weigh up your options.
These are skills that actually get stronger the more you practice them.
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Back to the video.
To show you what i mean, i want to give you another example.
You'll be happy to know this one isn't quite as numbers heavy as the previous one.
Let's say you got a loan the total amount doesn't matter, but the interest rate is at five percent.
So you've decided to start investing.
You open a tax efficient investment account online, you pick a global index fund and you set up automatic monthly contributions, just like you would if you were automating your savings.
So now everything's going great and you're patting yourself on the back for being kid sister, until one day you see a bunch of news headlines predicting a stock market crash.
In a panic you check your account.
You find that your investments are down by 6 and straight away you're regretting ever having invested at all.
None of this would have happened if you paid it safe and you used your money to pay off your debt.
Your return would have been modest, but it would have been a guaranteed 5%.
At this point, you might be tempted to sell your stocks and transfer the money into your bank account, even though this means you'll withdraw less than you put in.
This is known as panic selling.
It's extremely common, but it can leave you with less money today and prevent you building wealth for the future.
So if we look at this chart as an example, we can see that the SP 500, which is an index of 500 of the biggest companies in the US, has crashed several times since 1952, only to reach new heights later on.
So if you sold your stocks during any of these crashes, you'd probably regret it later.
That's why, most of the time, you'll be better off if you stay calm and you leave your investments alone.
So before you decide to prioritize investing over paying off your debt, you need to be really honest with yourself about your goals.
For example, how long are you investing for?
If you won't need the money for another 10, 20 or 30 years.
Panic selling during a market downturn will only hold you back and leave you worse off in the long run.
If you'll need the money in the next five years, it's probably a good idea to save the money instead.
No matter what your goals, it's a good idea to save an emergency fund before you start investing.
Not only can this be helpful in a practical sense, as in you'll have money set aside if your car breaks, if you need to fix a leaky roof, but it can even make you a better investor by making you less likely to sell your stocks whenever something bad happens.
Exactly how much you'll need depends on your situation.
Saving enough to cover three to six months of expenses can be a great start, but you might want to save more than this.
If you've got children, your income is unpredictable or you get quite anxious when thinking about money.
Because ultimately, it doesn't matter whether other people are focusing on paying off their debt or investing the second they get their first job.
What matters is what works best for you and your own situation.
If you're someone who loses sleep over debt or money in general, then prioritizing debt freedom could be the smartest move.
It's not always the most profitable, but it gives you peace of mind and keeps you from making expensive mistakes later on.
And so it might very well be worth the trade-off.
If however, your debt is low interest and you can manage it comfortably, investing small amounts alongside your minimum repayments can completely change your future.
You'll give your money more time to grow in the stock market, while you focus on making money and living your life.
If you found this video helpful, feel free to share it with someone who might need to hear it too.
And always, thank you so much for watching.
If you like this video, you'll like a bunch of my other videos.
I've got a whole investment playlist that I'll link over here.
Thank you so much and I'll see you next week.
